Thomas Grossman likes these kinds of markets — traders’ markets.
Grossman, who in 2000 founded the international equity desk at Stamford, Connecticut–based SAC Capital Advisors, which has $12 billion in assets, and who now runs $100 million emerging-markets hedge fund firm Union Avenue Advisors, revels in volatility. He found just the place to exploit it early this year.
China’s SSE A-share index — a cross section of stocks that trade on the Shanghai Stock Exchange — soared 30 percent in the first three months of 2009, from 1,820 yuan to 2,420 yuan, making it the world’s hottest equity index. Grossman sees the rally, which came on the heels of a 56 per-cent plunge that began in late 2007, as a huge opportunity.
The A-share surge was caused by the stimulus money the Chinese government is pumping into its economy, a strategy that pressured banks to start lending again — and, indeed, private sector borrowing increased by more than 30 percent in the first quarter. In mainland China, where the government zealously guards the domestic economy, the Shanghai market, which is not open to foreign investors, is the only equity exchange where residents can trade. Everybody else who wants to invest in Chinese equities has to buy so-called H shares, those listed on the Hong Kong Stock Exchange, which is where Grossman started to buy. “The movement in A shares was a good leading indicator of an H-share rally, as well as a rally in commodities and cyclicals more generally,” he says.
He was correct. In March, H shares moved to catch up with their Shanghai counterparts, mirroring indications sent by the Hang Seng China AH premium index, which tracks relative prices of the A shares as compared with H shares. (That index, which had taken off earlier in the year, fell by more than 13 percent from March 6 through March 16.) Managers who weren’t quick enough to spot the trend found themselves trailing the markets. Even Union, which is based in New York, failed to capture all the upside, though it delivered a 6.8 percent return for the quarter.
The H-share run-up was just half the trade, however. The other was in shorting “safe haven” stocks.
When the Chinese equity markets were falling in 2008 — as they did during most of the year — many investors who were precluded from moving into cash because of their client contracts went scrambling for safety. They bought shares of companies that had attractive fundamentals but weren’t tied to commodities and that often had a distant and less vulnerable exposure to China. Such safe haven stocks included Johannesburg-headquartered alcoholic beverage manufacturer SABMiller and U.K.-based telecommunications company Vodafone Group. Share prices in these companies outperformed in late 2008, as investors fled China, only to fall in February and early March, as these same investors reallocated to catch the upswing in Chinese stocks.
Grossman needed to be nimble. When the safety shares began rallying as part of the broader market upswing, he had to trade out of them quickly to avoid a short squeeze.
“It became very tricky in terms of timing,” notes Maiko Nanao, an Asia analyst with New York–based investment research and advisory firm Aksia. She says more-opportunistic managers are clearly favored in this investment environment, which requires an ability to see the whole board, and in three dimensions — the Shanghai index, the Hong Kong index and the safe-haven markets — not necessarily a strength of value-driven, fundamentals-focused investors.
“If the volatility continues, then I believe those fundamentals guys will struggle to stay in the game,” Nanao adds. “The trading-oriented managers will survive.”
