The latest year-to-date performance numbers from hedge funds that invest in China's red-hot market appear impressive. But stumbles by some funds in November raise questions about whether they are worth the heavy fees.

The average China-focused hedge fund is reporting a double-digit percentage gain for the 11 months ended in November, with a few up more than 100%.

788 China Fund, managed by Heritage Fund Management of Switzerland, was up 104%. Golden China Fund, managed by China-based Greenwoods Asset Management, was up 100%, while several other funds were up 30% or more, according to performance data reviewed by Dow Jones Newswires.

Anyone Could Have Scored?

But the numbers belie a worrisome performance picture for some funds. Chinese stocks have been a guaranteed moneymaker this year, so investors could have made impressive returns without paying hedge-fund fees. The Shanghai Composite Index returned 82% during the same time period, while the Hang Seng returned 44% — better than returns at some hedge funds.

A number of hedge funds took hits last month when Chinese stocks tumbled, raising questions about their ability to weather volatility. The Golden China Fund, for example, lost 9.3% in November, while the more recently launched Golden China Plus Fund, which focuses on high-growth companies and private equity, dropped 13%, bringing its year-to-date return to 30% at the end of November, according to performance data reviewed by Dow Jones Newswires.

Officials from Greenwoods Asset Management didn't return a request for comment.

A China-focused hedge fund run by Ginger Capital Management in Hong Kong, meanwhile, lost 17% last month, bringing its annual return to 40%. Officials from Ginger Capital Management didn't return a request for comment.

"What investors want to be looking for is risk-adjusted returns," said Christopher M. Schelling, director of strategic research with Thomson Corp. "I wouldn't be surprised if these Shanghai indexes give back a big portion" of their recent gains in coming months, he added.

One Winning Fund

One fund that seems to have weathered the November storm is 788 China Fund, which was up 2.4% last month despite a drop of 9% in the Shanghai Composite Index. Karim Daou, deputy manager of Heritage Fund Management, said the fund invests based on a macro strategy, moving in and out of sectors depending on their broader performance outlook.

"One of the main objectives is to protect the assets, then to beat inflation and interest rates, then to make performance," Mr. Daou said. "We're not benchmarked [to an index], so we have the flexibility needed to protect the portfolio."

While it isn't clear what exactly was behind losses in some funds, Veryan Allen, who advises institutional investors in Japan on investments including hedge funds, said the drops are a "red flag," suggesting the managers are "very long" and not managing risks well enough.

"One of the myths about China is that you can't go short," said Mr. Allen, adding that there are lots of ways to hedge, including shorting U.S.-listed American depositary receipts.

Investors who want only long exposure to China's growth can just as easily skip the hedge funds and their heavy costs, Mr. Allen said. He recommends investors take a look at China exchange-traded funds, which invest in baskets of stocks like mutual funds but trade on an exchange like stocks.

An investment in the iShares FTSE/Xinhua China 25 Index Fund ETF, for example, would have returned 72% through the end of November.

"We can all make money when the sun is shining," Mr. Allen said. "If for whatever reason you think China's going up, you might as well go with the simplest and cheapest and most direct product."

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**************************************
Paul D. Deng
Department of Economics
Brandeis University
IBS, MS 032
Waltham, MA 02454
www.pauldeng.com

BEIJING — Morgan Stanley's landmark deal to sell a $5 billion stake in itself to China marks a bold move by Chief Executive John Mack. If it pans out, it also will owe some of its success to the long experience and local ties of Wei Sun Christianson, Mr. Mack's steadfast lieutenant and point woman in China.

The surprise deal, announced Wednesday, gives the state-owned China Investment Corp., or CIC, a stake of as much as 9.9% in Morgan Stanley at a time when the U.S. investment bank is staggering under a multibillion-dollar write-down. While initiated by Mr. Mack, the agreement also helps solidify Ms. Christianson's status as one of China's premier deal makers, and perhaps the country's most prominent female investment banker.

The 51-year-old Ms. Christianson, born in Beijing, hails from a pioneering generation of Chinese who went abroad to study in the early years of China's economic overhauls and later returned to help reshape the country's financial system. Among the fellow Chinese she met in New York while studying at Columbia University School of Law in the late 1980s was Gao Xiqing, a Duke University-trained lawyer who later helped found China's stock markets. Mr. Gao today is president and chief investment officer of CIC, which was founded in September to manage $200 billion of China's $1.4 trillion in foreign-exchange reserves.

It isn't clear precisely what role Ms. Christianson and Mr. Gao, both of whom were in New York for Wednesday's announcement, played in the deal. Ms. Christianson declined to comment, and Mr. Gao couldn't be reached. But their involvement in the tie-up reflects the rising profile of their generation of Chinese in global finance, as China becomes an important force in world markets.

The CIC investment could prove a boon to both CIC and Morgan Stanley, although it also risks feeding suspicions among some U.S. politicians that the Chinese fund is seeking to obtain control of strategic assets — something CIC officials have long denied. For Morgan Stanley, it provides an infusion of capital, while for CIC the bet could prove lucrative if the U.S. investment bank is able to successfully emerge from its current woes.

CIC's strategy under Mr. Gao and his boss, Lou Jiwei, a former Chinese vice minister of finance, appears to be a mix of opportunistic big bets and more restrained portfolio investment. Mr. Gao and his colleagues have shown an appetite for prominent deals with the Morgan Stanley stake and a $3 billion stake in Blackstone Group LP earlier this year.

Ms. Christianson has spent much of her career working with Mr. Mack, following him when he left Morgan Stanley in 2002 to join Credit Suisse Group, departing from Credit Suisse when he was ousted in 2004, then rejoining Morgan Stanley in early 2006 after Mr. Mack's return there. In between, she spent 14 months as Citigroup Inc.'s lead investment banker in China.

Ms. Christianson didn't set out to be a banker. Growing up during the Cultural Revolution, a period of chaos from 1966 to 1976 when much of China ceased to function, she was unable to go to college until the late 1970s. When she could, she enrolled at a language institute in Beijing to study English and was on track to become a translator at the foreign ministry.

Eager to attend graduate school, she jumped at a chance to go to the U.S. in the 1980s. She graduated with honors in 1985 from Amherst College in Massachusetts, becoming the school's first China-born graduate, before attending Columbia's law school on a scholarship. It was at Columbia that she met her husband.

New York at the time was home to a small and tight-knit group of Chinese students studying law and finance — subjects almost completely alien to a generation that had grown up with Maoism. Mr. Gao, who had graduated from Duke in 1986, was working at the now-defunct law firm Mudge Rose Guthrie Alexander & Ferdon.

"At the time, most Chinese going overseas were aiming to study science," said Li Xiaoming, a friend of Mr. Gao's who graduated from Duke's law school in 1990 and is now managing partner of White & Case's Beijing office. "There were probably about ten Chinese lawyers then at Wall Street firms, making it a close group." Ms. Christianson and Mr. Gao remained friends as she climbed the investment-banking ladder and he rose through the ranks of China's bureaucracy.

After helping found the stock markets, Mr. Gao became vice chairman and chief executive officer of Bank of China's investment-banking arm and later served as vice chairman of the country's securities regulator and its national social-security fund.

Ms. Christianson briefly served as a regulator at the Hong Kong Securities and Futures Commission. After her third child was born, she decided she wanted a career switch and jumped into finance. Morgan Stanley gave Ms. Christianson her first break in 1998. "I was willing to try and ready to fail," she said in an earlier interview.

Today, Ms. Christianson, Mr. Gao and others of their generation are perpetuating the tradition they helped establish, by recruiting Chinese talent from overseas. CIC, for example, recently hired Li Yingru, a young Chinese who studied in the U.S. and had spent about a year and a half working at the California Public Employees' Retirement System.

Recession or not?

With recent econ stats all looking (surprisingly) good, why people still fuss about recssion? Here included are some heated debates on the topic: 3 videos from CNBC’s Kudlow and one quant piece from Jim Hamilton.

http://www.cnbc.com/id/15840232?video=612803140
http://www.cnbc.com/id/15840232?video=613298026
http://www.cnbc.com/id/15840232?video=613298033

The bears must wait another quarter

by James Hamilton

Currently available data on consumer spending make it very unlikely that we’ll see negative real GDP growth for the fourth quarter.

The BEA reported on Friday that seasonally adjusted real consumption spending grew at a 6.5% annual rate between October and November. As Calculated Risk has noted in the past, this takes much of the guesswork out of predicting what the fourth-quarter numbers will turn out to be. The quarterly consumption component of real GDP is just the average of these monthly numbers, so we now have two of the three months that will go into 2007:Q4 consumption spending.

Following CR, blue bars in the graph below represent the growth rate of the average real consumption during the first two months of a quarter relative to the average real consumption over the first two months of the previous quarter; (my numbers differ slightly from CR’s in that I’ve measured growth rates from changes in the natural logarithm, which correspond to continuous compounding and make the algebra a little simpler). Green bars in the graph report the actual growth rate for the quarterly consumption component of real GDP. The October and November 2007 data imply an estimate of the growth rate of real consumption spending of 3.2% during the fourth quarter of 2007.

The two-month estimate has an R² of 80% in predicting the actual quarterly numbers, and a root mean squared error of 80 basis points. The latter can be used to construct a 95% confidence interval for the 2007:Q4 forecast. The 3.2% estimate for 2007:Q4 implies a confidence interval between 1.6% and 4.8%. That Normal confidence interval can also be bootstrapped, by the way– only 4 out of the 69 errors since 1990:Q3 exceed 160 basis points in absolute value.

With 2007:Q4 real consumption growth in the ballpark of 3%, it’s extremely unlikely that we’ll see the negative real GDP growth for 2007:Q4 that some analysts had been predicting before the strong November retail sales figures came in.

—
**************************************
Paul D. Deng
Department of Economics
Brandeis University
IBS, MS 032
Waltham, MA 02454
http://www.pauldeng.com/

My strong critic toward sovereign wealth funds (SWFs) was buttressed by Becker’s recent piece that explains its fundamental flaws.

Why Sovereign Funds?
by Gary Becker

The growth of large government managed funds during the past few years has been spectacular. These funds are estimated to manage between $2-3 trillion, and their assets are increasing rapidly. Sovereign funds have grown mainly because of the run-up in fossil fuel and other commodity prices, although China is creating a large fund with the capital earned from its trade surplus in goods. If present energy and commodity prices continue, sovereign funds could have over $10 trillion in assets within a few years. I do not believe that the scale of these funds is a healthy development for these countries.

The largest fund is that by The United Arab Emirates, which is thought to have assets of about $900 billion. Next in size are the funds from Singapore, Saudi Arabia, Norway, and China: each has capital of about $300 billion. Following these giant government funds are another 20 or so funds with much smaller amounts of capital. Oil producing countries have about two thirds of the capital of all sovereign funds. The aggregate assets of sovereign funds greatly exceed the approximately $1.5 billion invested in hedge funds.

During the past couple of years, sovereign funds have begun to invest more aggressively in international companies. For example, the Abu Dhabi Investment Authority recently gave cash infusion of $7.5 billion to Citigroup to help replace bank capital that had been depleted due to the credit crunch. China’s State Foreign Exchange Investment Corp invested in the IPO of the large private equity company, Blackstone, and was embarrassed after the stock declined greatly from the issuing price. Sovereign funds have made other investments in private companies, and many more are expected.

With only a few exceptions, such as the fund of the Norwegian government, sovereign funds are secretive and not at all transparent. Lack of transparency is a major obstacle to citizens of countries with secretive sovereign funds in determining whether the money that automatically flows to the funds is being well spent. Even estimates of the total assets of most sovereign funds have to be arrived at through guesswork, and except for an occasional well-publicized transaction, their asset allocations are kept private. While private equity and hedge funds have also been criticized because they are little regulated- I do not share this criticism- they are paragons of voluntary disclosure and good governance compared to the vast majority of sovereign funds. Private equity and hedge funds voluntarily disclose information mainly because they compete vigorously for funds, whereas sovereign funds automatically get their resources because of government ownership of oil producing and other commodities.

Compounding the adverse effects of the extreme secrecy is that managers of these funds, being government employees on fixed salaries, have only limited financial incentives to try to achieve higher returns for given risk. Even when those in charge of sovereign funds hire private managers for some of their capital, there is still what economists call a principal-agent problem because government officials choose the managers. As a result, one would expect that the management of these funds would be excessively conservative to avoid investment blunders and bad publicity, or that managers would be tempted toward corruption by companies that want to attract investments from these funds. Or governments will use the funds for other government purposes, such as the just announced unwise decision by Brazil to create a sovereign fund to intervene in the foreign exchange market to shore up that country’s currency. Given that little information is available, it is very difficult to discover whether a fund is managed too conservatively, or whether corruption affects investments in a significant way.

A major reason behind the growth of sovereign funds is the desire by oil producing and other countries to avoid what happened during previous booms in commodity prices. Vast revenues in the past were spent with little concrete results to show later on. Countries now recognize that the enormous boom in their export prices, such as oil close to $100 a barrel, is not likely to last. That makes it prudent to save rather than spend most of the revenue that is being collected. The desire to save the surplus is commendable, but that consideration alone does not imply that governments rather than households should do the saving.

Central banks and fiscal agencies should accumulate assets during years with high oil and other commodity prices, or what are in other ways unusually good times, in order to protect against the adverse effects of bad times on fiscal and foreign trade deficits. However, the Abu Dhabi fund and the other large funds, and many smaller ones, have far more assets than is necessary for cyclical management of government portfolios. Instead of government funds retaining the excess assets, they should be distributed as national dividends, or as reductions in taxes.

One advantage of distributing most of a funds’ assets as dividends, or reduced taxes, is that since families at different stages of the life cycle have very different investment needs, they would invest such a dividend in ways that best suit their individual needs. Younger couples that are investing in children, and actively accumulating wealth, will spend their dividends on buying homes, cars, and other consumer durables, saving for the education of their children, and investing in mutual funds and other financial intermediaries. Since older persons with adult children already own their homes and other durables, they would spend their dividends mainly on conservative financial instruments.

To be sure, countries accumulating some of the largest funds are not at all democratic, so that any national dividend would only go to a relatively small fraction of the total population. But so too are any benefits from the investments of sovereign funds, so a national dividend would not be any worse in this dimension.

People’s Investment Company
January 29, 2007; Page A16, WSJ

For Wall Street, the big news out of China this month is that the country will “actively explore and expand the channels and methods for using foreign-exchange reserves.” The Communist Party might hive off a big chunk of its $1 trillion stash and invest abroad on behalf of its citizens, a la Singapore’s Government Investment Corporation. That may be a boon for bankers, but it’s not necessarily a smart idea for China.

This is yet another scene in the Party’s balancing act between economic liberalization and state control. China’s exchange-rate policy — the catalyst for its huge foreign-exchange reserves — is at the heart of the debate. By more or less pegging the renminbi to the dollar, Beijing accumulates foreign-exchange reserves when it mops up the incoming greenbacks. The policy has spurred an enormous boom, giving Chinese and foreigners the confidence to invest without worrying about price volatility.

This has also bought time for China to reform its broken financial sector — a task that’s far from finished. At the same financial conference at which the government investment idea was floated, Premier Wen Jiabao kicked off the reform of the Agricultural Bank of China, more than half of whose loan portfolio is rumored to be non-performing; it will take perhaps $100 billion or more to bail it out.

So why hive off foreign-exchange reserves into a Singapore-style fund? For one, China’s policymakers may be frustrated that their efforts to encourage money to flow abroad aren’t working quickly enough to offset the tide of incoming capital. The so-called Qualified Domestic Investor Initiative scheme, which lets Chinese investors buy bonds abroad, has attracted only a few billion dollars so far.

But there are good reasons for that. Today, Chinese investors see better prospects at home. The Shanghai stock market is up more than 110% over the past 12 months, and property prices are still healthy. Chinese investors probably aren’t turned on by buying U.S Treasury bonds. If the Party were serious about opening their capital markets, they’d let investors buy General Electric on the New York Stock Exchange, or a vacation home in Thailand.

It’s more likely that Beijing likes the GIC-like setup because it would keep the Party’s hands on the money. Singapore’s fund hasn’t released public accounts since its founding in 1981; its stated total under management, at $100 billion, hasn’t changed in years. But at least Singapore has a reputation for clean governance; the same can’t be said of China’s bureaucracy.

Beijing’s policymakers could also make political hay domestically by telling citizens that they will get more return for their renminbi — which could then be invested in, say, education or health care. This is the “negative carry” argument — the idea that foreign investors are receiving double-digit returns on their dollars, while China’s central bank receives single-digit returns when it invests renminbi in U.S. T-bills.

But that’s not the way it really works. Foreign-exchange reserves are liabilities on a central bank’s balance sheet, not found money. Up to a certain point, reserves assure foreign investors that a country has ammunition to fight an attack on its currency, such as during the 1997-98 financial crisis. Once reserves accumulate beyond that point, more fundamental questions about government policy have to be raised. Instead of creating an opaque government institution to manage reserves, China would do better to tackle the root problem: the need for more capital freedom.

A Revisit of Chinese Stock Market: Was I Wrong?

01/04/2007

In early 2005, I predicted bearish Chinese stock market in the medium term. Back then, the Shanghai Composite Index was only around 1000. Nobody quite understood how this could happen with the economy soaring every year at double-digit rate. Now, the index stands high at 2650, a 165% jump from 1000. If just count from October to December last year, the index jumped 800 from 1800, almost 45% increase. One word: unbelievable!!!

The bear market I predicted was out of two reasons. For one, there will be huge piles of state-controlled non-circulating stocks waiting be to put into the market, creating an oversupply. Two, China is working toward floating her capital account (sooner or later), domestic investors will want to invest overseas seeking better return instead of earning pity banking interest. This will create a shortfall of demand. Both forces drive down the market in the medium term. Supply and demand work like magic. Is it that simple?

It turns out the supply side of the story was right. But the privatization of state controlled non-circulating stocks completed sooner than expected. The demand side’s just totally opposite. Instead of a shortfall, we had a huge surge.

Several events contributed to the flip of the demand.

First, Chinese government announced appreciation of the yuan in the first half of 2005. And with continuing pressure from the U.S., yuan is expected to appreciate further. This contributed a huge inflow of speculative capital, part of it flowing into the stock market. This is the most important factor in this round of stock rally.

Second, with IPOs of monster big Chinese state banks, and with backings of the prestigious Investment banks such as Goldman Sachs and RBS (in return for favorable access to Chinese banking business), the market psychology turned to Chinese stock holders’ favor.

Third, Chinese government took a gradual approach on freeing its control on capital account. Although the state, in replacing individuals, begins to invest abroad, the process is too slow. The expected outflow of capital did not happen.

Is the huge outflow of domestic capital ever gonna happen? I don’t think so. Here is why? 1) Chinese investors are relatively poor informed about the foreign markets. They do not have experience investing abroad. Simply too much uncertainties out there. 2) The financial institutions in China are still backward. Institutional investors, like mutual fund and pension fund, are inexperienced either.

Now here is the tough question: With Renmingbi expected to rise further, will China suffer similar boom-and-bust in Japan since early 90s? At least, this is what economists like R. McKinnon are worrying about.

Read on, next time…

-Paul