Why China’s rebound is rich in alpha opportunities for hedge funds

Chinese growth is unbalanced and plateauing, giving rise to alpha-generating opportunities in relative value plays, Lyxor Asset Management strategists said this week.

Senior strategists Jean-Baptiste Berthon and Philippe Ferreira, and Bernadette Busquere Arnal, EU head of hedge fund research, pointed to increased fundamental pricing and a more diversified and decorrelated set of themes amid more affordable valuations within Chinese names.

While equities opportunities might be less directional, alpha is improving, they explained, with the market exuberance seen earlier in the year easing off and setting the stage for a more stable stock-picking environment.

As a result, the prevailing backdrop has provided for more dynamic portfolio management among hedge funds. Following the vaccine rollout, many switched from certain export-driven stocks in China to sectors buoyed by domestic demand, such as healthcare and retail. Lately, managers have piled into areas strengthened by stimulus, such as infrastructure, while offloading tech exposures sensitive to the US-China tariff tensions.

“Overall, they have produced modest alpha year-to-date and have been resilient during the correction,” Berthon, Ferreira, and Arnal wrote in a market commentary.

“High correlation and average dispersion across managers’ returns suggest relatively homogeneous positioning but differentiated in sizing.”

Earlier this month, Pictet Alternative Advisors described China as a “very conducive environment” for hedge fund managers, with the economic pick-up helping fuel returns among its managers.

Looking ahead, Lyxor believes certain structural patterns will continue to support alpha, though strategists sounded a note of caution on potential risks posed by geopolitics and policy changes on credit and stock shorting.

Widening market access and a bigger share of China in EM and world indices will help draw additional flows, while a broader wider set of investors and business would bolster market depth. At the same time, inefficiencies in onshore exchanges offer arbitrage.

“Multiple themes generate catalysts, including the transition from an export to a consumption model, a rapid urbanisation, the rise of innovation leaders in tech and beyond, an ageing population, the green transition, [and] the enhancement of corporate governance.”