GAIM: China soft-landing looking more likely

17 Jun, 2014

A Chinese hard landing is looking less likely following central government intervention in the economy.

This comes as a number of fund managers and experts speculate the once-booming Chinese economy has run out of steam and risks imploding. Legendary hedge fund manager Jim Chanos of Kynikos Associates, told an Alternative Investments Conference at the London School of Economics that China was a ticking time-bomb.

“I think the Chinese government has done just enough to prevent a hard landing. The government has eased its monetary policy and cut interest rates, so I am of the belief that there will be a soft landing,” said Gavyn Davies, chairman of Fulcrum Asset Management, speaking at the GAIM Conference in Monte Carlo.

There are widespread fears that China’s property  market is overheating. Property investment in China accounts for approximately 13% of the country’s Gross Domestic Product (GDP), which is double the US share at the height of the bubble in 2007. Real estate construction, meanwhile, is believed to comprise 20% of GDP. Davies said this could jeopardise China’s growth and highlighted property prices remained very high in urbanised areas. 

A hard-landing in China would disrupt global growth. A paper in February 2014 by Societe Generale said a decline in growth in China from 10% in 2010 to 2% would reduce global economic growth by 1.5 %.

A growing number of hedge fund managers remain bearish about China. Many cite local government debt, fuelled by unhealthy borrowing from the country’s shadow banking market, is rapidly becoming unsustainable.

Despite fears the economy is overheating, some fund managers are looking to Chinese investors for business.  A mutual recognition scheme between mainland China and Hong Kong could provide traditional asset managers with long-term opportunities by giving them access to Chinese capital although it is still unclear if the liberalising measures will be extended to hedge funds anytime soon.

The initiative has been welcomed although there are a number of practical challenges and uncertainties which could stymie asset managers’ plans in China. There has been limited clarity from regulators about the rules and it is likely only vanilla products will be allowed to be marketed.

The rules would also enable foreign asset managers domiciled in Hong Kong to sell to mainland investors without having to partner with a Chinese firm or apply for a license, something which has frustrated asset managers. Fund managers are generally required to partner with a domestic asset manager, securities company or bank if they want to distribute their products. These institutions will charge commissions, which will eat into the management fee, or even the performance fee.

China is gradually opening up to foreign asset managers including hedge funds. The Qualified Domestic Limited Partner (QDLP) Programme permits a limited number of foreign hedge funds to tap the wealthy private investor community in Shanghai for capital. However, this is subject to onerous restrictions.

Only six hedge funds – Canyon Partners, Citadel, Man Group, Oaktree, Winton Capital and Och Ziff – have received approval from the Shanghai regulator to raise capital on the mainland. Furthermore, the regulator has limited all of these hedge funds to an overall quota of $300 million to manage, which will be split six ways. Reports suggest only Citadel and Canyon Partners have raised decent sums of capital so far. Hedge funds have found there to be distribution challenges in China as their domestic asset manager, securities companies or banking partners have little commercial incentive to work with alternatives managers as the capital hedge funds are allowed to raise is so limited.  

Nonetheless, the Shanghai regulator is said to be in talks with other hedge funds hoping to take advantage of QDLP. Experts predict the first movers into China will reap huge rewards although there is always a risk Beijing could scrap the experiment arbitrarily.

China is not averse to hedge fund investing. Its sovereign wealth funds are known to dabble in hedge funds although many other allocators, such as insurers, are generally cut off or prohibited from investing in the asset class. Hedge funds are not included in the list of Qualified Domestic Institutional Investor (QDII) list of approved investments, although a study by Barclays Prime Services indicated the rules could be changed as China continues to liberalise its capital markets.

Chinasoft landinghard landingFulcrum Asset ManagementJim ChanosQDLPQDII