Hedge funds adopt China in the short term, but no end of the world in sight

LONDON (Reuters) – A record drop in the Chinese currency in June yielded big dividends to some of the world's leading hedge funds, even though these trades do not reflect growing bets on an economic crash.

The second largest economy in the world has its problems. He is exposed in any escalation of his trade dispute with Washington and his massive debt pile has raised concerns about the health of his banks and state-owned companies.

And betting against his CNY = CFXS yuan, whether via the CNH = D3 offshore markets or CNYNDFOR = currency derivatives, has been a favorite of hedge funds for years.

Having made big bets in 2015 and 2016, thinking that the Chinese economy was going to collapse, these funds felt the heat while the intervention of the central bank dampened the fall of the currency and made their trade in the short run too expensive.

While this game has faded since Beijing has allowed broader access to its onshore markets and tightened its grip, some hedge funds have continued to bet against the yuan for various reasons.

For Kevin Smith, investment director at Crescat Capital's hedge fund, the record-breaking 4% drop in the yuan against the dollar in June was the confirmation of a three-year wager that the Chinese currency would weaken.

After paying, she contributed to more than 80% of the company's 23% loss in 2017.

"We have been bearish on China for three years and have crossed the desert. It was something that really started for us in 2015 and is back for us now, "said Smith.

Crescat used options to maintain a lower cost position last year and maintains the theme of the devaluation of the yuan among the fund's best trades of $ 56 million.

"The options give us a way to stay in the game and have substantial exposure when it finally moves and downgrades.With our risk controls, we have been able to stay in the situation when a lot of Other hedge funds … have really been squeezed out. "

(GRAPHIC: Reversing China's Yuan Risk – reut.rs/2NCSeu5)

ON

Over the course of l. In the summer of 2015 and early 2016, Hyman Capital and Corriente Advisors took the lead in betting on the Chinese economy via foreign exchange derivatives, which paid off when Beijing devalued the markets to stabilize its markets. Both funds declined to comment on current positions.

These transactions also peaked as Beijing's ambitions to encourage the use of its currency abroad fueled the claims that China would struggle to stem an avalanche of capital outflows following the collapse of its stock markets.

But since then, China has taken steps to improve markets and allow better access to foreigners by launching investment channels between its major stock exchanges in Shanghai and Hong Kong.

"For hedge funds, the world has gone from haphazard devaluation to China," said Stephen Coltman, a senior investment manager of the investment strategy team. investment of Aberdeen Standard Investments. While currency-specific funds were still evolving in the yuan, macro-hedge funds – which bet on the macro movements of equities, indices, rates and currencies – were largely absent.

This can be seen in the offshore derivatives market in undeliverable futures, which did not value the massive depreciation of the yuan, Coltman said.

The futures prices on the CNHFOR = CNHFOR = one year contracts show a 56 pips reduction in spot levels, but in early 2016, the reduction was over 350 pips due a sharp slowdown in convulsed markets in China.

Although a CNH1MRR indicator of one month = and CNH3MRR of three months = risk reversals, a ratio of puts to calls, for the yuan have risen slightly in recent days, it remains far in below the levels of the third quarter of 2015 and early 2016.

Yuan movements were also more orderly this time around.

As trade tensions between the world's two largest economies intensified, the People's Bank of China allowed the CNY = CFXS renminbi to weaken by nearly 5% over 11 trading sessions from mid-June to a August 2017 low of 6.7204 yuan for one dollar.

The currency is now close to the lows of one year. Contrary to the 2015 hard landing fears, most investors believe that the Chinese economy is resting on solid foundations and that the weakness of the yuan could be only a tool for easing the downturn. parallel to targeted reductions in reserve requirements.

"Our big data indicators in the field indicate an upside risk for the consensus on economic activity," said Isabelle Mateos y Lago, chief multi-asset strategist at BlackRock Investment Institute in London.

[TRADUCTION] (GRAPHIC: Difference between offshore positions and spot rate – reut.rs/2L9rG1V)

POSITIONS OF "NOSE DISTURBANCE"

More importantly, the cost of short positions on the yuan bets against Beijing an expensive venture. With the improvement of access to onshore markets, a pool of yuan down – 600 billion yuan ($ 90 billion) compared with more than 1 trillion yuan in December 2014 – short sellers are vulnerable to sudden spikes in day-to-day financing costs. times last year.

Even taking the route of foreign exchange derivatives is relatively expensive. Implied volatility on the offshore yuan, a key factor for pricing options, is greater than that of its Asian counterparts.

"These are positions that bleed for months and can hurt performance," said Kenneth Broux, FX strategist at Société Générale in London.

China-focused hedge funds fell 4.18% in June, compared to their global counterparts, which posted stable returns over this period, according to Eurekahedge data.

Kaspar Hense, a member of Bluebay Asset Management, was late in joining. He began selling the offshore yuan at $ 6.45 last month, believing that Beijing would accept the inflationary impact of a weaker currency.

While the fall of the yuan has made his position much more profitable than expectations, he is not afraid that it will skid and trigger an avalanche of capital outflows.

"We do not believe that the Chinese economy is in danger and the monetary losses are much more manageable for the decision-makers this time," he told the Mayfair Fund which manages $ 60 billion .

Douglas Greenig, founder of Florin Court Capital, said he took advantage of rising and falling currencies in 2017 and 2018, as his models of quantitative funds painted the market for trend prices and then took advantage of them. .

"Positioning seems much less extreme than (before) … When positioning goes on, there are fewer people to enter the business and push the trend further."

(GRAPHIC: RMB deposits in Hong Kong – reut .rs / 2NH7lTf)