Northwest Hedge Funds Gain as Much as 46% on ‘Trade of the Year’

The “trade of the year” is reaping rewards for investors in Northwest Investment Management (HK)’s hedge funds.

Cheaper valuations of Chinese companies’ Hong Kong-quoted class-H shares will persist for at least another three to six months, said George Philips, chief executive officer of the company that oversees about $700 million of assets. That is helping the firm to profit from their discounts to China-listed, yuan-denominated class-A shares, Philips said.

“We decided it was the trade of this year; it has proven to be right so far,” he said. “Not only is this being profitable, most of it is still on the table. The opportunity is now not much smaller than a week and a half ago.”

The company’s $435 million Northwest Fund returned 15 percent this year through April 10 and 12 percent this month. The $20 million Northwest China Opportunities Fund gained 46 percent in 2015, including 18 percent this month, said Mark Smith, the head of business development. A Eurekahedge index tracking hedge funds focused on Asia including Japan gained 3.8 percent in the first quarter. Its Greater China hedge-fund gauge rose 6 percent in the same three months.

The Hang Seng China Enterprises Index of Chinese companies listed in Hong Kong has rallied more than 20 percent since March 27, bolstered by China’s expansion of the number of fund managers eligible to buy stocks in the city. The surge has raised questions over whether the profitable trade exploiting the pricing gap between A and H shares will soon fizzle out.

Mind the Gap

The mainland shares of 85 companies listed in both Hong Kong and China are valued as much as 164 percent higher than their Hong Kong stocks after the recent H-share rally, according to data compiled by Bloomberg.

A link between the Shanghai and Hong Kong stock exchanges started in November has given foreign investors unprecedented access to A shares traded in Shanghai and broadened Chinese investors’ ability to purchase Hong Kong stocks. The reform was expected to narrow the pricing gap between the markets.

Fund managers such as Northwest have been cutting investments in China-listed stocks and convertible bonds in favor of H shares after the Shanghai Composite Index surged 53 percent last year on monetary easing to stimulate growth. The rally is about five times the Hang Seng China Enterprises Index’s 2014 gain, widening the pricing gap with A shares.

Northwest boosted the A-H share trade to about 60 percent of the long investment in the Northwest Fund, from about 10 percent mid-last year, Smith said. It buys a basket of securities, including H shares, convertible bonds, options and swaps, hedging the trade with bets against the A-share index.

Factors that can drive the narrowing of the pricing gap over coming months include easing a requirement that Chinese investors have at least 500,000 yuan ($80,662) in their securities and cash accounts to buy H shares through the exchange link, which has so far excluded most individuals, said Philips. A link between the Shenzhen and Hong Kong bourses as well as Chinese companies using excess cash to buy back their H shares could also reduce the difference, added Smith.

“This is the kind of thing that doesn’t happen very often,” said Philips.

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