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For Those Trying To Short, There's A Will
2007/08/28 10:13
CHINA'S STOCK market has defied the law of gravity, pushing the benchmark Shanghai Composite Index up 91% this year to its latest record Friday -- despite lofty valuations, rising interest rates and global market tumult.
So how can investors bet on a little law enforcement?
When markets soar like China's has, investors gleefully bet on a crash by selling the market short. Others will try to hedge their positions, giving up potential gains to limit their losses.
'The demand for short exposure will increase, and has been increasing, especially with the markets doing so well,' says Andy Mantel, managing director at Pacific Sun Investment Management in Hong Kong.
The only problem: Regulators don't permit shorting in the domestic Chinese stocks, known as Class A shares, that have seen the most frenetic buying. Investors can bet against Chinese companies that trade elsewhere, like Hong Kong or New York, but these stocks haven't been caught up in the Chinese investor frenzy, so they aren't as expensive.
But there are ways for foreign investors to get around China's restrictions, though these techniques have limitations and risks of their own. And shorting, of course, is dangerous game, as anyone who bet against overvalued tech stocks in the 1990s can attest.
Mr. Mantel and other fund managers say the most feasible way to get that short exposure is to use one of the small but growing number of offshore exchange-traded funds that track Chinese A-share indexes.
There are two A-share exchange-traded funds listed in Hong Kong. The iShares FTSE/Xinhua A50 China Tracker began trading in 2004, while another fund, the WISE CSI 300 China Tracker, had its debut in July. (Most other China ETFs track the more-accessible shares of Chinese companies traded on offshore markets, which, again, have performed quite differently than Class A shares.)
Because ETFs can be bought and sold like stocks, they can be borrowed for short selling, and no regulatory restrictions apply. An investor arranges to borrow the shares from someone else, sells them, and then hopes to buy the shares back at a lower price, returning the shares to the original owner and pocketing the profit.
'It's one of the very few vehicles which allow people who hold A-shares to hedge their exposure. That has certainly been a major point of interest to investors,' says Mark Talbot, chief executive officer for Asia ex-Japan at Barclays Global Investors, the Barclays PLC unit that manages the iShares line of ETFs.
The catch: The iShares fund has about $1.8 billion in assets, meaning the amount of short exposure it can provide is limited. And not all of the investors who own the ETF are willing or able to loan out their shares for short selling. According to data published by the Hong Kong stock exchange, the A50 China Tracker had 2.7 million shares sold short in July, or just 5.5% of its total shares outstanding of 49.2 million.
So investors who do short the ETFs usually have to do so in a fairly focused way, rather than making a big bearish bet. 'They hold individual companies in the A-share market on the one hand, and short the iShares A50 on the other,' says Barclays's Mr. Talbot.
Mr. Mantel says his China-focused fund has in the past used the ETF to short the A-share market to provide a counterweight to some individual stock holdings. He isn't currently short but says he may well be again in the future, either through the ETF or other instruments.
Large investors also can make more targeted short bets against Class A shares by working through a brokerage in China's Qualified Foreign Institutional Investor, or QFII, program, those the costs of these trades can be steep.
QFIIs -- the only foreign investors allowed to trade in Class A shares -- buy the shares on their own account and sell investors, usually fund managers, a derivative that mimics the performance of the shares. A QFII can also sell an investor a derivative that, instead of mimicking a standard long position in a stock, mimics a short position.
Say an investor wanted to go short five million shares of Baoshan Iron & Steel, which closed at 17.63 yuan ($2.33) a share Friday. That position is valued at 88 million yuan, or about $11.6 million. The investor approaches a QFII that happens to be holding 25 million shares of Baosteel on behalf of various other clients, and is willing to use some of those shares for the short trade.
The QFII sells the investor a derivative contract that mimics a short sell. The QFII then hedges its own exposure to that derivative by selling five million of the Baosteel shares it holds. No actual short selling has occurred in China -- all that has happened is that one shareholder has sold some shares -- but the investor has still gained short exposure to the stock.
Three months later the investor decides to close out the trade, and so the QFII buys back the five million shares in the market. If Baosteel has in the interim fallen to 14 yuan a share for a total of 70 million yuan, the QFII owes the investor the difference of 18 million yuan, minus fees.
If, on the other hand, Baosteel has gone up to say, 20 yuan a share, then the investor owes the QFII the losses on the trade of nearly 12 million yuan -- plus the fees and trading expenses.
This trade isn't an easy one to execute, though. 'The amount that can be shorted in this way is very limited, because the QFII positions are not that large and not always available to lend out. So the ability to impact the whole market is very limited,' says Fraser Howie, head of structured products at the brokerage firm CLSA Ltd.
That could change if Chinese regulators carry out their promise to introduce stock-index futures on the domestic exchanges. Futures based on the FTSE/Xinhua A50 index already trade in Singapore, but volume is minuscule -- apparently because of a legal challenge over the source of the index data. A spokeswoman for the Singapore exchange said the licenser has assured the exchange that they have valid contractual arrangements.
Andrew Batson
So how can investors bet on a little law enforcement?
When markets soar like China's has, investors gleefully bet on a crash by selling the market short. Others will try to hedge their positions, giving up potential gains to limit their losses.
'The demand for short exposure will increase, and has been increasing, especially with the markets doing so well,' says Andy Mantel, managing director at Pacific Sun Investment Management in Hong Kong.
The only problem: Regulators don't permit shorting in the domestic Chinese stocks, known as Class A shares, that have seen the most frenetic buying. Investors can bet against Chinese companies that trade elsewhere, like Hong Kong or New York, but these stocks haven't been caught up in the Chinese investor frenzy, so they aren't as expensive.
But there are ways for foreign investors to get around China's restrictions, though these techniques have limitations and risks of their own. And shorting, of course, is dangerous game, as anyone who bet against overvalued tech stocks in the 1990s can attest.
Mr. Mantel and other fund managers say the most feasible way to get that short exposure is to use one of the small but growing number of offshore exchange-traded funds that track Chinese A-share indexes.
There are two A-share exchange-traded funds listed in Hong Kong. The iShares FTSE/Xinhua A50 China Tracker began trading in 2004, while another fund, the WISE CSI 300 China Tracker, had its debut in July. (Most other China ETFs track the more-accessible shares of Chinese companies traded on offshore markets, which, again, have performed quite differently than Class A shares.)
Because ETFs can be bought and sold like stocks, they can be borrowed for short selling, and no regulatory restrictions apply. An investor arranges to borrow the shares from someone else, sells them, and then hopes to buy the shares back at a lower price, returning the shares to the original owner and pocketing the profit.
'It's one of the very few vehicles which allow people who hold A-shares to hedge their exposure. That has certainly been a major point of interest to investors,' says Mark Talbot, chief executive officer for Asia ex-Japan at Barclays Global Investors, the Barclays PLC unit that manages the iShares line of ETFs.
The catch: The iShares fund has about $1.8 billion in assets, meaning the amount of short exposure it can provide is limited. And not all of the investors who own the ETF are willing or able to loan out their shares for short selling. According to data published by the Hong Kong stock exchange, the A50 China Tracker had 2.7 million shares sold short in July, or just 5.5% of its total shares outstanding of 49.2 million.
So investors who do short the ETFs usually have to do so in a fairly focused way, rather than making a big bearish bet. 'They hold individual companies in the A-share market on the one hand, and short the iShares A50 on the other,' says Barclays's Mr. Talbot.
Mr. Mantel says his China-focused fund has in the past used the ETF to short the A-share market to provide a counterweight to some individual stock holdings. He isn't currently short but says he may well be again in the future, either through the ETF or other instruments.
Large investors also can make more targeted short bets against Class A shares by working through a brokerage in China's Qualified Foreign Institutional Investor, or QFII, program, those the costs of these trades can be steep.
QFIIs -- the only foreign investors allowed to trade in Class A shares -- buy the shares on their own account and sell investors, usually fund managers, a derivative that mimics the performance of the shares. A QFII can also sell an investor a derivative that, instead of mimicking a standard long position in a stock, mimics a short position.
Say an investor wanted to go short five million shares of Baoshan Iron & Steel, which closed at 17.63 yuan ($2.33) a share Friday. That position is valued at 88 million yuan, or about $11.6 million. The investor approaches a QFII that happens to be holding 25 million shares of Baosteel on behalf of various other clients, and is willing to use some of those shares for the short trade.
The QFII sells the investor a derivative contract that mimics a short sell. The QFII then hedges its own exposure to that derivative by selling five million of the Baosteel shares it holds. No actual short selling has occurred in China -- all that has happened is that one shareholder has sold some shares -- but the investor has still gained short exposure to the stock.
Three months later the investor decides to close out the trade, and so the QFII buys back the five million shares in the market. If Baosteel has in the interim fallen to 14 yuan a share for a total of 70 million yuan, the QFII owes the investor the difference of 18 million yuan, minus fees.
If, on the other hand, Baosteel has gone up to say, 20 yuan a share, then the investor owes the QFII the losses on the trade of nearly 12 million yuan -- plus the fees and trading expenses.
This trade isn't an easy one to execute, though. 'The amount that can be shorted in this way is very limited, because the QFII positions are not that large and not always available to lend out. So the ability to impact the whole market is very limited,' says Fraser Howie, head of structured products at the brokerage firm CLSA Ltd.
That could change if Chinese regulators carry out their promise to introduce stock-index futures on the domestic exchanges. Futures based on the FTSE/Xinhua A50 index already trade in Singapore, but volume is minuscule -- apparently because of a legal challenge over the source of the index data. A spokeswoman for the Singapore exchange said the licenser has assured the exchange that they have valid contractual arrangements.
Andrew Batson