February 4, 2020 / 9:36 AM / 21 days ago

Hedge funds hold their nerve on China, seek opportunities

SHANGHAI/NEW YORK, Feb 4 (Reuters) - Hedge funds are holding their nerve on China's ability to rebound quickly from the coronavirus outbreak rattling global markets, but many are also adding caveats as they try to predict the potential economic fallout.

Mainland China stocks fell sharply on Monday when Shanghai and Shenzhen markets opened after an extended Lunar New Year break, wiping out nearly $700 billion in market capitalisation.

But the broad blue-chip CSI 300, which fell almost 8% on Monday, rose 2.5% on Tuesday.

"In a crisis, everyone feels the sky is falling. But the sky does not fall in the end," said Gu Weiyong, chief investment officer at Shanghai-based hedge fund manager Ucom Investment Co.

He said he favoured battered stocks of airport operators such as Shanghai Airport on the basis that an economic recovery was only a matter of time.

Shares in Shanghai Airport were down 19% so far this year as of Monday's close, but gained 8% on Tuesday.

Oil prices, often considered a barometer of investor confidence in the global economy, eased off 13-month lows hit on Monday, with benchmark Brent crude gaining 0.8% to $54.90 a barrel.

Futures prices also indicated an opening gain for the U.S. S&P 500 index to add to a 0.7% bounce on Monday.

"The market seems to have reacted quite reasonably," said Switzerland-based David Nietlispach, portfolio manager for Pala Asset Management, who added that it was, however, a "wait and see" moment for Chinese stocks, as the government continued to battle the epidemic and assess economic damage.

HEDGES, VOLATILITY BETS

Stock market volatility – a favoured play for many hedge funds - has risen sharply in recent days. On Monday the VIX index measuring U.S. market volatility, reached its highest in more than three months.

Christopher Stanton, chief investment officer at Sunrise Capital Partners LLC, on Monday bought derivatives that rise in value if volatility picks up.

The fund uses computer-driven strategies to time short-term market swings.

"Am I happy about it? No. Because everything in my body tells me this is not over yet," he said pointing to the risk that a faster-than-expected increase in the number of coronavirus cases could trigger more selling.

The epidemic has claimed more than 420 lives in mainland China but has spread to several countries such as the United States, Japan, India and Singapore.

"What do you think isolating the world's second-largest economy is going to do?," he said. "It can make (trade) tariffs look like a mosquito bite."

Yuan Yuwei, who manages a global macro fund from China's eastern city of Hangzhou, said the sectors most vulnerable to an epidemic included property, retail, luxury goods, travel and leisure.

He shorted several stocks ahead of China's new year holiday, including Yum China and Starbucks, while also betting on some potential gainers, such as Chinese online video platform Bilibili.

"In such a crisis, if you're cool-headed, there are plenty of opportunities to jump into a trend," he said.

Yang Xiaofan, Japan-based hedge fund manager, was however more pessimistic, and is shorting copper, whose price typically tracks global growth, while buying silver as a less crowded safe-haven trade than gold.

"The new virus itself is not that horrible,but the supply chain disruptions and factory closures caused by city lock-ins and holiday extensions would deal a real blow to the economy in the near term," he said.

"Supply side problems cannot be addressed by rate cuts or liquidity injections." (Reporting by Sam Shen in Shanghai, Ira Iosebashvili in New York and Marc Jones in London; Writing by Jennifer Hughes; Editing by Jacqueline Wong)

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