US hedge funds betting on trade deal with China

Fund managers optimistic an agreement is in the offing, while others remain skeptical

Anticipating a US-China trade deal soon, US hedge funds have increased their holdings in United States-based companies that derive significant revenue from China, research by a major New York investment bank found.

At the start of the fourth quarter this year, the funds' median holdings of China-related stocks represented 3.4 percent of US hedge funds' total market capitalization, up from 2.7 percent at the beginning of the third quarter — an increase of about 26 percent, said the report from Goldman Sachs Group.

Hedge fund managers bet on "improving headlines regarding the US-China trade war" as stocks "priced rising optimism regarding a potential trade deal" and loaded up on China-exposed stocks, the firm said last week in a report.

"Funds increased portfolio weights in cyclicals and China-exposed stocks as the market rallied in late third quarter," Goldman Sachs said. "Funds remain tilted toward growth rather than value and positions in healthcare and big tech reflect little fear of policy risk."

So far, the bet on a trade deal has paid off.

Companies earning significant revenue in China have outperformed the broad market since mid-August. Hedge funds holding stock in companies with the significant sales in China returned an average of 17 percent — outperforming the S&P 500 by 7 percentage points. Stocks in an average hedge fund, including those that didn't bet heavily on a US-China trade deal, rose an average of 10 percent this year, Goldman Sachs said.

To date in 2019, the Dow Jones Industrial Average set 12 record closes. The Dow set a new high of 26,966.00 on July 3 when US President Donald Trump said he would resume trade negotiations with China and not impose additional tariffs. The index closed at 28,038.65 on Nov 18, an all-time high.

Despite solid early returns, the increase in holdings of China-related stocks raises a basic question: Are hedge fund managers being smart or overly optimistic by betting on a US-China trade deal?

"Event-driven global macro hedge funds relish as an ideal investment opportunity any major policy outcomes that are associated with lots of uncertainty," Andrew Karolyi, a professor of economics and management at Cornell University, told China Daily. "The ebb-and-flow of US-China trade negotiations is an idea around which these kinds of funds can double-down on behalf of their investors."

But Dealbreaker, a website covering the financial industry, remained skeptical that a trade deal will be reached and scorned the decision by hedge fund managers to increase holdings in China-related stocks in anticipation of a resolution.

"The economy is like a zeppelin, buoyed aloft by nonsensical optimism, sentiment is political and the world feels increasingly less stable and more prone to a litany of crises both financial and political," according to Dealbreaker.

Since the middle of last week, markets in the US — including the Dow, Nasdaq and the S&P 500 — have dipped as resolution of the continuing dispute appeared more difficult.

"My guess is that Trump will blow hot and cold right up to the deal date, Dec 15," economist Gary Hufbauer, a trade expert at the Washington-based Peterson Institute for International Economics, said in an email to China Daily.

"I'm still expecting a respectable 'phase one' agreement: Postponement of the Dec 15 date for tariffs (to become effective), a partial rollback of the September tariffs, significant agricultural and Liquefied Natural Gas purchase commitments by China, plus promises on intellectual property rights and an end to forced technology transfer," he wrote.

Researchers at Goldman Sachs reviewed the top 10 holdings of 833 hedge funds holding equity valued at $2.1 trillion. The most widely held stocks are Amazon, Microsoft, Facebook, Alphabet (Google), Micron Technology and Alibaba, the Chinese holding company focusing on e-commerce, internet and technology sectors.

Other US companies generating significant revenue in China and widely held by US hedge funds include chipmakers Qorvo, Qualcomm, Nvidia, Broadcom, Intel and Marvell Technology. They also commonly hold shares in technology companies such as Applied Materials, Texas Instruments, IPG Photonics, and Teradyne. Casino operators Wynn Resorts and Las Vegas Sands get significant revenue from Chinese tourists, the researchers found.

Hedge funds buy and hold onto stocks — called "going long" — if managers believe the market will rise. If managers believe a stock will fall, it's "shorted" — selling borrowed shares at the current price, pocketing the cash, and repurchasing shares at a lower price to return to the original owner. The hedging strategy is intended to reduce market risk, but, critics say, the tactics are inherently risky. If, for example, a shorted stock rises, the hedge fund must replace the borrowed shares at a higher price and take a loss.