Delivering Alpha 2021

Hedge funds slash exposure to China amid ongoing regulatory crackdown

Signage at the Alibaba Group Holdings Ltd. headquarters in Hangzhou, China, on Wednesday, March 24, 2021.
Qilai Shen | Bloomberg | Getty Images

Hedge fund exposure to Chinese equities and indexes listed in the U.S. has dropped to a two-year low due to a sharp reduction in prices and selling of positions, according to a new client note by Credit Suisse. 

The firm showed a decline in so-called net exposure — a way of showing riskiness to swings in Chinese equities — from upward of 2% at the end of last year to roughly 0.75% as of Aug. 25. 

China exposure through Aug. 25
Credit Suisse

The move comes as one-third of hedge funds held ADRs at the end of the second quarter, according to a Goldman Sachs analysis of the latest 13F filings from 813 funds. ADR stands for American depositary receipt, which serve as proxies for shares of foreign companies that list in the U.S. 

A slew of regulatory actions have sent the average Chinese ADR plummeting. The Chinese government has largely focused its crackdown on areas like data security, for-profit education and gaming. President Xi Jinping is looking to encourage "common prosperity" by narrowing the wealth gap in China. 

The market has been responding to uncertainty about what this heightened regulation means for the private sector. The Nasdaq Golden Dragon China ETF, which tracks companies listed in the U.S. that do a majority of their business in China, declined 1.6% in the month of August but that followed a drop of more than 22% in July. 

Credit Suisse says that "2021's sharp drop in ADR net exposure owes to both price declines and client reductions as investors priced in regulatory uncertainty." 

Third Point's Dan Loeb told investors that he had pared back almost all of his exposure to China in recent months out of fear that Xi would "continue to exercise his power over financial markets," The Wall Street Journal reported, citing an unnamed investor on the call. 

While not considered a hedge fund, Cathie Wood pared back her exposure to China through several of her Ark ETFs in late July, selling some of Tencent, Baidu and JD.com, and more recently, reclaimed more JD.com. Tencent and Pinduoduo on the dip. 

Specific stock picking has been key. During August, crowded China shorts are down more than 4%, benefiting managers betting against the names by profiting on the declines. On the long side, crowded longs are lower by just 0.2% for the month. 

Goldman said that the recent sell-off in Chinese names has put a dent in hedge fund returns. Equity-oriented funds were in the red during July, posting losses of 0.76% on an average-weighted basis, according to HFR. Those were the first monthly declines in about 10 months, the data showed.