Hedge funds have had a tough 12 months and the first quarter of 2016 was the worst in at least seven years. Grief, however, is always relative. Those suffering in New York or London may find some comfort when they look at what their counterparts in China and Hong Kong are enduring.
On Tuesday, China Everbright, a Hong Kong-based money manager that runs more than $5 billion, said it would close one of its China-focused hedge funds after a drop in performance during last year's stock market rout. Keith Wu, the managing director of China Everbright Assets Management, said investment opportunities were scarce and the firm had decided to consolidate its equity offerings.
That a hedge fund oriented toward China would have lost money in 2015 shouldn't come as a surprise. Hedge funds like the one Everbright is closing are only good at making money when others don't precisely because they hedge.
Therein lies the major hurdle for any money manager claiming to adopt such a strategy in China. Shorting of mainland stocks is expensive and limited, while the appetite for shorting Hong Kong-listed Chinese stocks has been slumping. That leaves derivatives, but there's only one index-option contract and zero for individual stocks, and futures are far and few between. Once you exclude the short side of the strategy, hedge funds are left with just the one approach. And China has been a very bad market to be long for the past year.
A swathe of new rules isn't helping either. Last August, regulators said short sellers would have to wait one day before covering their positions. That reduced what little short selling there was in China because it meant investors would have to sit on bets for at least 24 hours, by which time anything might have happened. Beijing also clamped down on the trading of stock-index futures, which limited volumes on the CSI 300 Index, a favorite investment destination for hedge funds.
Then there's the issue of competition. There are a lot of rich people in Asia's largest economy and over the past five years, the number of companies being established to manage that wealth has soared.
As with any crowded market, gaining the upper hand gets a lot harder. And whenever there's a surplus of something, so too will there be winners and losers.
China watchers should expect many more hedge funds to follow in the footsteps of Everbright's doomed Dynamic Opportunities Fund. Life's going to be tough around those parts for a while yet.
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