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October 28, 2019 12:00 AM

Japan, China market disruptions turn into gold for Segantii

Eric Uhlfelder — Eric Uhlfelder
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    Segantii Capital Management Ltd. has cut its teeth on finding opportunities in volatile markets across Asia.

    Segantii Capital Management Ltd. capitalizes on market disruptions, including two major events that occurred in Japan and China.

    These investments have helped the fund outpace various benchmarks.

    For example, a 2014 Japanese policy initiative to stimulate the economy pushed corporations to restructure and become more shareholder friendly, buy back shares and sell off or fully integrate subsidiaries. Segantii saw opportunities in purchasing shares of subsidiaries before they were acquired by either their parent companies or external interests.

    One of several dozen such investments Segantii made was in semiconductor equipment manufacturer Hitachi Kokusai Electric Inc., a subsidiary of Hitachi Ltd., in early 2016.

    "We anticipated HKE was likely to be in play," said CEO Kurt Ersoy, "but weren't sure who or when the buy would occur."

    During the first quarter of 2016, it started building up a long position at an average price of ¥1,500. To offset Japanese market risk, it used futures to short the TOPIX broad market index. By the end of 2017, KKR & Co. Inc. had stepped in and purchased the company at a final price of ¥3,000, around which time Segantii sold out.

    Between 2016 and 2017, Japanese trades represented up to 8% of Segantii's book. They generated 10% of the fund's total net returns in both 2016 (6.69%) and 2017 (8.56%).

    A key relative-value trade that Segantii has been in since its inception targets the pricing gap between shares trading on China's multiple mainland stock markets in Shanghai and Shenzhen and those listed on the foreign-investor-oriented market in Hong Kong.

    Though these markets are denominated in yuan and Hong Kong dollars, respectively, shares of the same company would often trade at significantly different prices that went well beyond exchange rates. This was due to a gap in investment knowledge, approach and demand by their respective shareholders.

    Large-cap companies that were trading on the mainland as A shares — which are mainly available to local investors — were typically priced lower than their Hong Kong H shares, where foreign investors have driven up the prices of more well-researched enterprises.

    Inversely, smaller, less well-known companies, with less foreign interest, have traded at discounts in Hong Kong compared to their mainland market prices.

    In April 2014, Chinese and Hong Kong authorities gave this trade a boost when they announced a new initiative — the Shanghai-Hong Kong Stock Connect — to promote more open and less restricted capital flows between those two markets. Segantii jumped on the enhanced convergence possibilities even before the new policy was codified.

    "The key risk," said Mr. Ersoy, "was adoption of the new rule was not a sure thing."

    One of many trades Segantii put on included a significant long position in Ping An Insurance Co., whose market cap is now more than $200 billion. Its A shares had been trading at a 27% discount compared with its Hong Kong-listed H shares. To offset market risk, the fund shorted Ping An's H shares.

    When the new rules took effect in December 2014, the homeland discount was transformed into a 10% premium over Hong Kong shares, by which time the fund had sold out of its position, according to Mr. Ersoy. Segantii also cashed in on the same convergence experienced by Hong Kong-based exchange-traded funds that invested in A shares.

    Profits from these trades accounted for half the fund's 2014 gain of 34.79% and nearly half the fund's 29.59% returns in 2015.

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