Hedge Fund Managers Are Bearish and Bullish on China

Patrick Wolff has never been to China. But the hedge fund manager has strong opinions on how events there might affect the markets, and his portfolio, in the next few years. Wolff, CIO of San Francisco–based Grandmaster Capital Management, which manages about $140 million in assets and returned 22.18 percent last year, was bearish on the world’s second-largest economy before he launched his firm in 2011 with funding from PayPal co-founder Peter Thiel. He believes China is in a deflating economic bubble and doubts that Beijing can engineer a soft landing.

In an April 2012 investor letter summarizing Grandmaster’s views on China, Wolff said he didn’t think the country was “an exception to the rule that once an emerging economy reaches a certain level, democratic and capitalist reforms are needed to promote growth.” He’s also pessimistic that China can absorb the knock-on effects of recent government spending in the private sector just because it has less debt per person than most developed countries.

“I believe that some form of democracy and capitalism are the best ways we know to organize our government and our economy,” Wolff says. “China does not have either one.” He’s surprised that some of the same investors criticizing the current U.S. administration for too hands-on an approach to market and bank regulation also believe that China will keep booming thanks to government intervention.

Wolff is one of many hedge fund managers who are down on China’s economic prospects. Fellow bears include short-seller James Chanos, founder of $5.2 billion, New York–based Kynikos Associates. But not everyone forecasts a hard landing for China. How the Chinese economy will perform in the coming years and how that will influence the U.S. and other countries are among the hedge fund industry’s most hotly debated topics.

Daniel Arbess is a China bull. A former international corporate lawyer, Arbess runs Xerion, a $2.8 billion event-driven special-situations strategy at New York–based financial services firm and investment bank Perella Weinberg Partners. During the past 25 years, he’s spent much time in China. The country’s long-term fundamentals are sound, Arbess maintains, asserting that its ongoing development and shift toward a consumption-driven growth model are important to the world economy. But he concedes that identifying the causes of China’s future expansion and translating them into investments are two different things.

Arbess and Wolff express their respective views on China by avoiding direct exposure to its stock markets and other Chinese securities. Wolff, who invests in companies with little or no connection to the Chinese economic story, focuses on U.S. stocks. Grandmaster’s top long investments for 2012 included specialty retailer Cabela’s, CBS Corp., Howard Hughes Corp. and Sirius XM Radio, as well as some U.S. financials.

In Arbess’s view, “the Shanghai stock market is dominated by state-owned enterprises whose managers are not necessarily pursuing shareholder value maximization as their highest priority.” As for the Hong Kong Stock Exchange, he thinks it still trades plenty of private companies whose financial reporting is unreliable. Hedge fund China bears share this concern about accounting standards. For Arbess the best way to access China’s growth is to invest in multinational corporations, letting their management navigate the risk and find opportunities.

Take Apple. In 2010, Xerion contended that analysts were discounting its growth potential in China; today 20 percent of the U.S. computer maker’s revenue comes from there. Apple was a losing position for Grandmaster in the last quarter of 2012.