Chinese equities have faced a challenging year globally, yet one hedge fund strategy stands out for delivering robust returns amidst the volatility. According to data compiled by Goldman Sachs Group Inc., investing in Chinese stocks using the classic long-short trade yielded over 10% returns through late June this year. In comparison, the US saw gains of about 7%, while Europe lagged behind at less than 6%.
The success of this strategy in China can be attributed to significant divergences within the market. State policies favoring industrial capacity expansion contrast sharply with struggles in the consumer and property sectors amid economic uncertainties. The market structure itself, characterized by high retail participation, low institutional involvement, and sparse analyst coverage, creates fertile ground for structural inefficiencies, noted Bernard Ahkong, CIO for global multi-strategy alpha at UBS O’Connor in London.
Despite recent curbs by Beijing on short selling, which have affected onshore quantitative funds, offshore fundamental stock pickers remain relatively unaffected. They leverage strategies such as shorting American depositary receipts or Hong Kong-listed shares, or using derivatives to bet against mainland equities.
While the long-short strategy has shown promise in China, it remains relatively underutilized globally. Among approximately 600 equity long-short funds worldwide, only 35 focus exclusively on China, reflecting waning global interest amidst prolonged market downturns.
Examples of sectoral divergence in Chinese stocks this year underscore the strategy’s effectiveness. The energy sector of the MSCI China Index surged 27% through mid-July, while healthcare plummeted 27%. In contrast, the best-performing sector in the S&P 500, technology, saw a 34% rise, with even the worst-performing sector, real estate, managing a 0.1% gain.
UBS O’Connor’s China long-short fund, for instance, recorded a 15% return through mid-July, bolstered by gains in state-owned enterprises like PetroChina Co. and China Shenhua Energy Co., aligned with Beijing’s push for improved shareholder returns.
Despite perceptions of unpredictability, Chinese policy-making often telegraphs key initiatives like state-owned enterprise reforms well in advance, providing long-short investors with clearer visibility compared to their counterparts in developed markets.
Recent stricter regulations targeting short selling indicate China’s resolve to curb market volatility. Analysts anticipate these measures will predominantly impact high-frequency trading strategies while sparing longer-term investors focused on company fundamentals. Offshore managers can still access short positions through derivative contracts or futures tied to mainland equity indexes, ADRs, or Hong Kong shares.
Challenges persist for China-focused long-short funds seeking to attract new investors amid waning foreign interest. Despite superior performance in 2024, many funds struggle to expand, constrained by global skepticism toward hedge fund fee structures and historical returns.
Industry experts, however, remain optimistic about the long-term viability of the long-short strategy in China, citing its unique market dynamics and relatively low correlation with developed markets as favorable conditions for generating alpha.
“The low correlation and high dispersion normally indicate a good opportunity to generate alpha,” noted Wei Li, multi-asset quant solutions portfolio manager at BNP Paribas Asset Management in Hong Kong.
In conclusion, while navigating regulatory hurdles and investor skepticism, China’s two-speed market continues to offer substantial opportunities for hedge funds employing the classic long-short strategy, buoyed by distinct sectoral dynamics and proactive government policies.
