Marco Polo sees China stocks bottoming soon

HONG KONG (Reuters) - Mainland Chinese stocks, down 41 percent since last October, are likely to find a bottom by this quarter or next, a China-focused hedge fund manager who earned triple-digit returns in 2006 and 2007 said on Tuesday.

A slide in valuations and double-digit earnings growth both point to a near-term rebound, though China's price control policies could be a major risk, added Marco Polo Pure Asset Management Chief Executive Aaron Boesky.

"There is a tremendous amount of cash on the sidelines and burgeoning liquidity still coming. We think that a recovery is imminent in the next few quarters," he told the Reuters Hedge Funds and Private Equity Summit in Hong Kong.

"We could see some continued softness in Q2, Q3, but we think ultimately the market will answer back."

The benchmark Shanghai Composite Index .SSEC fell 34 percent in the first quarter, its biggest quarterly loss since 1992 and second worst since China's modern stock market was established at the end of 1990.

The drop marked an end to one of the world's great equities bull markets, during which index jumped over sixfold between June 2005 and last October.

Marco Polo's flagship Pure China Fund, which had $170 million in assets under management at the end of February, is focused entirely on the mainland A-share market.

Launched in September 2004, it lost money that year and the next before rising more than 105 percent in 2006 and 133 percent in 2007. It fell 2.72 percent in the first two months of this year, compared with a more than 17 percent decline in the Shanghai Composite Index .SSEC.

PRICE CONTROL RISKS

Boesky, a U.S.-born Mandarin speaker who studied at Beijing Foreign Affairs College, said that because China effectively bans the shorting of mainland shares, the firm is prepared to aggressively raise cash as a hedging tool when stock markets tumble.

Cash at one point rose to as high as 60 percent of the portfolio in the first quarter as the fund sold off many of its Chinese stocks after they had hit the firm's target prices.

But the Hong Kong-based executive said the fund has been buying back into the market recently, bringing cash down to 35 percent.

"For those investors in the world who thought that the Shanghai market was so overvalued when it was at a 72 (times price-earnings multiple) last October, take another look at it now at a 24-25 PE ... it's almost three times cheaper," he said.

"It's a good time to take a look for the market."

But Boesky said he did see risks, including the recent response of Chinese authorities to rising prices.

With inflation hitting an 11-year high, authorities introduced controls on a range of goods from instant noodles to milk, calling it a temporary intervention. It was the first time in over a decade that Beijing waded into the food market.

"The biggest risk is price controls ... price control typically distorts the economy," said Boesky. "The best way to manage inflation is to let it happen."

Given the increasing purchasing power in China, Boesky said the fund is overweight Chinese consumption stocks, food and beverage, tourism, hotel, infrastructure and securities companies.

It is underweight the export sector, citing shrinking margins and the negative impact of the rising yuan currency.

Marco Polo earlier this month launched its second China-focused hedge fund with about $20 million under management. The fund will allow it to invest outside of the mainland Chinese market.

Boesky said using ideas generated by its mainland company research, the fund could trade China-related plays from Singapore to London, and also use the hedging strategies available in major markets.

The fund executive thinks mainland managers could soon have a new hedging tool at their disposal. After meeting with the China Securities Regulatory Commission last December, Boesky said he expected stock index futures will launched in this quarter.

Beijing has delayed the launch of stock index futures trading for more than a year due to concerns that it would bring instability to China's stock market.

(For summit blog: summitnotebook.reuters.com/)

(Editing by Kim Coghill)