Saga of Financial Markets


Last updateSat, 29 Jul 2017 12am

Back You are here: Home Market Market Update News Why Hedge Funds Bet Against Emerging Markets

Why Hedge Funds Bet Against Emerging Markets

Hedge fund managers are positioning themselves to profit from a slowdown in developing economies, led by overheated credit markets in China. A number of them are buying protection on sovereign debt through credit default swaps. In short, they are betting against emerging markets because of their concerns on slower growth in China and potentially a “hard landing”.

Why they are negative on China?  Here are some of the reasons:

  1. Based on Noster Capital’s estimation, a London-based hedge fund investor, since the start of the 2008, China's ratio of credit-to-GDP has exploded and it is now at higher levels than those seen on the cusp of the credit crises in the U.S. and U.K. in 2007, Japan in 1990 and Korea in 1998. Pedro de Noronda, Founder of Noster, said "China is a very leveraged economy and a lot of the assets that are against the leverage are not cash generative. China is relying on the shadow banking system as a Ponzi scheme to let it roll over credit. The cracks in China in the past couple of weeks could well be the canary in the mine shaft."
  2. Patrick Wolffe, Managing Partner of US Hedge Fund Grand Master Capital, pointed out that in the West GDP is "calculated on a final sales basis" but that China bases its figures on levels of production – in other words, in China, one can build a building and it can contribute to its GDP even without selling it.

Here are some of the hedge funds betting against China or wider slowdown in emerging markets:

  1. ESG, majority owned by Carlyle Group with AUM of $4.5 billion, is currently raising money for Nexus, a $20 million China-focused macro portfolio that it launched in June last year, bought sovereign credit default swaps on China to express its bearish view - in a China "hard landing" scenario the fund could make 100%, while it could lose 30-40% if its bearish view doesn't play out.
  2. Forum, N.Y. based with AUM of $180 million, owns a basket of CDS on South Korea, South Africa, Brazil, Turkey, Australian Corporates and Japanese Corporates.  In the basket there are also a number of shorts on emerging market corporates, which are highly geared and sensitive to drops in commodity prices and GDP slowdowns.  The fund is also short Lebanese sovereign bonds and long Qatari sovereign CDS to play the theme of geopolitical uncertainty in the region.
  3. Noster which owns CDS on emerging markets sovereigns.

De Noronha said: "The trade has a very asymmetric risk/reward profile. A gigantic wall of money is on the other side of the trade and all of them have the illusion that they will be able to get out just before the others. Emerging markets is the asset class that is most dependent on liquidity and they have had loads of it with quantitative easing in most G7 countries.

"As we are nearing the point that that excess liquidity is withdrawn, the first and biggest casualties will be emerging markets, where the unsophisticated money has flooded in the search for yield and where the risk/reward is probably one of the most unattractive ones that existed in the past decade or so."


The Wall Street Journal, Harriet Agnew, 2013-07-11, “Hedge Funds Bet Against Emerging Markets”