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China market hit trough in Q3, says UBS hedge fund

Ms Fitzpatrick thinks China has the greatest leeway, policy-wise, than any other government, and what Beijing is "tactically doing now is shifting to what they know works".


HAVING guided UBS O'Connor's investments in Chinese equities to profit this year amid the rough tumble over the last three months, the head of UBS's hedge fund unit thinks the Chinese market hit its trough in the third quarter.

Dawn Fitzpatrick, the fund's global head and chief investment officer, told The Business Times the volatility has also set hedge funds apart from those that had merely been "riding a beta trend". Beta indicates the degree of risk in an investment that results from market exposure. This contrasts with idiosyncratic, or unpredictable, risk.

O'Connor is one of several hedge funds that invest in liquid stocks and bonds, mainly through a strategy known as relative value. With this, traders can pair two securities to try to make a profit, by shorting an overpriced security and buying a related security that they deem to be cheap.

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"That style of investing in a volatile and dynamic backdrop kind of plays to that style's strength. The key is to be able to nimbly move capital around, between opportunity sets," said Ms Fitzpatrick.

She points to the Chinese and Hong Kong markets as examples, with the trading conditions there deteriorating from June after a good run in the first half of the year. The fund, which does not invest in Chinese bonds, has made money on China this year, she added.

"It does look like we've troughed in the third quarter when it comes to China," she added, noting that the policy focus on the equity markets has been right, even though it was derailed in the short term. "They are clearly pivoting back to their old economic drivers, in terms of housing and autos. I think China has more degrees of freedom, policy-wise, than any other government in the world. And I think what they are tactically doing now is shifting to what they know works."

The hedge fund unit managed US$5.7 billion as at Oct 1. Assets under management (AUM) are unchanged from the start of September.

The fund does not disclose performance details. As an indicator, data provider Preqin showed funds with a relative value strategy have been the only ones that posted a positive return in the third quarter, on average.

Funds were hit blue in the face in the three months ended September, given the market volatility, with Preqin's All-Strategies Hedge Fund benchmark posting a loss of more than 4 per cent - the benchmark's worst quarterly return since the third quarter in 2011. Against this, relative-value funds eked out an overall gain of 0.26 per cent over the quarter.

"We've had six years of global risk assets going straight up," said Ms Fitzpatrick. "What you're seeing play out in the hedge fund industry this year is you're clearly being able to delineate the funds that were creating value for their investors, and funds that were riding a beta trend."

Still, she is wary about the loss of liquidity in the markets, noting this "recalibration" could go on for a couple of years. This comes particularly as global banks are still reducing their balance sheets. "The lower return on balance sheet assets like US Treasuries, (they) become far less attractive assets to loan against. And that has knock-on implications for liquidity."

She expects to see more opportunities in arbitrage linked to mergers - a trade that was the forte of proprietary trading desks at investment banks. Merger activity among listed companies is the strongest since 2007.

With merger arbitrage, a hedge fund tries to make a profit while netting out the risk that an acquisition will fall through, by buying shares of the target firm - which should trade below the acquisition price - and going short on the acquiring company.

"The largest market participants in those merger spreads, historically, were the investment banking proprietary trading desks. And because they are largely out of business . . . you have a really large supply of deals, and the demand for those type of trades is significantly less," Ms Fitzpatrick said.

Returns now range from 6 per cent to double digits, depending on the risk, which reflects significantly wider merger-arbitrage spreads than historical levels, she added. "That's a fertile place for investing now."

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