It is no accident that over the years, and especially in the past few months, we have been profiling what in our opinion is one of the few, truly worthy hedge funds, Horseman Global, which despite (or maybe due to) being net short stocks since the start of 2012 (and long bonds), has outperformed 99% of its peers and has generated tremendous returns during its lifetime.
Just last month, in "Short For Three And A Half Years And Outperforming 98% Of Traders: This Hedge Fund Did It", we explained how in July the fund generated a 7% return, just as all the beta-levered, momentum-monkey, hedge fund hotel residents were losing steam.
One month later, and following a ghastly August in which virtually everyone lost money, the $2.5 billion Horseman was up a whopping 9.4%, and is now up 17.7% for the year.
And no, you can't allocate the funds you redeemed from Ackman to Horseman at this moment: "Due to a high level of interest in the fund, we are again soft closing the fund. Any investment into the fund will need approval."
But it was not easy, as the following story from Russel Clark, Horseman's CIO, recounts in the fund's monthly letter.
Being bearish on China for the last few years has reminded me of the 1987 action classic "Predator". In the film, a special ops force are ordered on a mission to an unnamed South American jungle.
However, while trying to complete their mission they are slowly hunted down by an alien creature. At each stage, they think they have managed to trap it, but it continually defies anything any of them have seen before. It moves and lives in the trees! It can turn itself invisible! It has infra-red and heat vision! It has a shoulder mounted laser rifle! Needless to say most if not all of the members of the team succumb to its abilities....
For bears, much like the alien in Predator, the Chinese government has continually used special abilities that were previously unknown. The first surprise came in 2008/9 when China embarked on an immense stimulus program, where decade's worth of infrastructure investment was fast tracked to counteract the global slowdown, a punishing period for anyone short at the time.
Eventually, the infrastructure boom came to an end, and there seemed to be an excess of housing in the market. Many funds were bearish on Chinese property developers in 2011, only to see the government promote housing investment. Many property stocks, went on to rally 300% or more. Your fund had been short property names, but having been caught on the wrong end of policy before, managed to avoid getting caught in this attack on bearishness.
Then in 2014, with the real exchange rate of the Renminbi surging as both Japan and Europe devalued their currencies via Quantitative Easing, it seemed that China was running out of options. If they cut interest rates to promote growth, then they would have to devalue. And yet, somehow the government was able to manufacture a stock market boom. This meant that capital that would usually leave China as interest rates were cut stayed in China to participate in the stock market.
Bearish investors in China had been picked off relentlessly and seemingly effortlessly by the government and the central bank. But then just as suddenly, the stock market started to sell off and the pressure on the currency began to build. This led to the small devaluation we saw in the Renminbi in August.
The People's Bank of China ('PBOC') has fallen into a classic emerging market trap in my view. There was some pressure on the exchange rate, but they were unwilling to raise rates to defend the currency, so chose to devalue. However, as they wished to promote stability they devalued by a relatively small amount, in the hope that this will reduce capital outflows.
In this they are completely wrong. The small devaluation will do nothing for the export sector, but creates huge amount of fear in the investing public, that has previously assumed the exchange rate was "safe". Contrary to reducing pressure, the small devaluation will actually increase the capital outflow, and the pressure on the exchange rate. If the PBOC had really wanted to reduce capital outflow, it would have needed to move the exchange rate much more significantly.
In my experience, in the mind of the international investment community, small devaluations tend to encourage even more capital outflow, which in turn leads to even larger devaluations. Or to borrow a line from Predator, "If it bleeds, we can kill it".
In the movie, the Predator dies.
As for the punchline, Clark goes out in style: "Your fund remains long bonds and short equities."