(Bloomberg) -- Benjamin Fuchs was an Asia hedge fund star, managing $5 billion at his company’s peak. Now, the former Lehman Brothers Holdings Inc. trader is one of the highest-profile casualties of China’s property crisis and battling to turn his firm around.

BFAM Partners (Hong Kong) Ltd.’s hedge fund lost almost 11% last year and a further 20% in the first seven months of 2022 as a series of bets on Chinese real estate developer bonds turned sour, after the firm mistakenly assumed the authorities would support the sector. While the losses aren’t existential or unique to BFAM, the company is bracing for possible redemptions and under pressure to retain staff.

It’s a remarkable reversal of fortune for a hedge fund that expanded assets by more than 15-fold over nine straight years of gains, in part benefiting from China’s seemingly inexhaustible economic expansion and red-hot property market. It shows how even longtime China investors were blindsided when the tide turned, as Xi Jinping’s administration abandoned its overleveraged builders as part of a broader crackdown designed to curb excesses and achieve “common prosperity.” 

“We definitely got caught on our back foot,” Fuchs, 53, said in an interview in his office overlooking Hong Kong’s Victoria Harbor. “I would be lying if I said it’s not massively stressful.”

Investors from Hong Kong to New York have watched in dismay as about $120 billion in value has been wiped from the bonds of China’s risky developers. The offshore market is now all but shut to the sector. Home prices have fallen for 12 straight months and sales frequently grind to a halt amid rolling Covid lockdowns.

In response, BFAM has devised a plan to get through the crisis. It will ring-fence hard-to-sell China credit assets, mostly from property developers, into a so-called side pocket to avoid a fire sale and give them time to recover, according to a person familiar with the matter, who asked not to be identified as the information is private. It will shift focus to more liquid bets such as stock and currency volatility, convertible bonds and block trades. And it will aim for assets under management of about $1.5 billion to $2 billion -- a size where the fund’s returns have been strongest.

Katarina Royds, BFAM’s head of investor relations, declined to comment.

In a region dominated by stock pickers, BFAM invested across asset classes, with Asian credit, particularly Chinese real estate companies’ debt, becoming a key part of the portfolio. In the boom years, trading Chinese high-yield bonds was a big money-earner, but the downturn in the property market caught Fuchs -- and many others -- by surprise.

When China introduced its “three red lines” policy in 2020, which capped the debt that developers could take on in an attempt to reduce excesses in the sector, the move was seen as a way to make growth more sustainable, but observers such as Fuchs still fully expected the government to step in and support the industry when necessary, like it had done in the past. 

It didn’t happen. In December, China Evergrande Group defaulted on its borrowings, as did Kaisa Group Holdings Ltd., another major developer. A string of other defaults followed. China’s property firms were in crisis, and the government did nothing -- because it was now focused on reducing debt and speculation and narrowing the nation’s wealth gap.

“I don’t think any of us appreciated that pivot until it was really too late,” Fuchs said.

Some Chinese property company bonds lost more than 90% of their value.

The California native had lived through high-profile busts before. After spending part of his childhood on a hippie commune, he moved to Japan in his early 20s, teaching English and working as a waiter in a karaoke bar before landing his first finance gig at Barings Plc. Fuchs was on the same global futures and options team as Nick Leeson, whose rogue trades out of Singapore drove Barings to bankruptcy in 1995.

Fuchs joined Lehman in 1995, eventually managing an internal fund trading global assets. Then in 2008, the storied bank collapsed in a pivotal moment in the global financial crisis. 

Four years later, his former Lehman colleagues would form the backbone when Fuchs launched his own hedge fund firm in Hong Kong, starting with about $320 million in assets.

It was the golden era of Chinese junk bonds. BFAM posted double-digit gains in five of its first six years, partly from such investments.

Chinese real estate companies’ bonds had been a key part of the portfolio from the start. In 2015, Fuchs pitched buying a basket of single-B-rated Chinese property debt at the Sohn Asia investment conference for hedge funds in Hong Kong. The “extremely cheap” assets had an average yield of 10%, which exaggerated their risk of default, he said.

“We were early in that cycle and made a lot of money in the good years,” Fuchs said.

By the end of May 2021, BFAM was overseeing $5.03 billion, up more than 15-fold from June 2012. It manages about $2.9 billion today. At its peak, the company employed 99 people (that’s now in the 70s), and traded everything from credit default swaps to Lebanese rates and securities tied to swings in the Turkish lira. It even assembled an in-house troop of data scientists. From its inception through the end of 2020, BFAM posted an annualized return of 12.5%.

“It was one of the key hedge funds I wanted to sound out on primary deals,” said Patrick Liu, a former Asia co-head of debt capital markets at UBS Group AG who’s now chief executive officer of Admiralty Harbour Capital Ltd., a debt-focused boutique investment bank in Hong Kong. “They were one of the few shops with independent views.”

BFAM holds the bonds of about 30 developers, with no “super-large” position in any of them. That would protect it against the odd default, Fuchs reasoned. As an investor, he’d navigated situations where companies failed to pay before: BFAM had played a key role in Kaisa’s debt restructuring after it became the first Chinese developer to default on offshore bonds in 2015. 

Yet none of that prepared him for the avalanche that was to come.

Fuchs’s team watched in disbelief as Evergrande’s default engulfed the entire industry, leading to an indiscriminate selloff in Chinese property bonds, irrespective of their financial strength.

But the support measures that Fuchs expected for the industry didn’t come. It was far from unreasonable to expect them: The sector had been a vital source of China’s growth since the 1990s and with about 70% of household wealth tied to real estate (and about a third of bank loan books), the price of housing is crucial to maintaining social stability.

In fact, things were going to get worse. China’s pursuit of long-term Covid lockdowns would batter home sales. The lack of government support “wasn’t fatal,” Fuchs recalled. But the lockdowns really were “a double whammy.”

To be fair, BFAM is far from the only investor who got burned by failing to grasp the Xi administration’s reform plans. Stock picker Brilliance Asset Management, for example, apologized for its losses after Beijing decimated the after-school tutoring sector. 

Nor was it the only Chinese property junk bond investor to get hit by the across-the-board losses. Fidelity International’s China High Yield Fund has plunged about 40% this year, while a similar fund of Value Partners Group Ltd. is down 38%. 

Fuchs describes the property crisis as one of the toughest moments in his career. He declined to give a figure for investor redemptions, but said a smaller size would make the firm more nimble. BFAM may have expanded too quickly, he said.

Another common concern for hedge funds working through losses is retaining top talent. BFAM can’t charge performance fees until it recovers the losses, which Fuchs says may take a year or two. That can have an impact on bonuses, making it harder to keep employees.

But Fuchs says he has no intention of giving up and going home. He opened an office in London in August, partly to provide flexibility for employees who want to work from there. BFAM is still hiring, planning to recruit more credit analysts in key Chinese property markets after adding one in Shanghai early this year.

He’s counting on an easing of pandemic curbs by the end of this year, and expects debt restructuring at overleveraged property companies. In the past month, there have been signs of government support, with Beijing offering 200 billion yuan ($28.5 billion) of special loans to restart stalled housing projects and developers selling bonds in the domestic market with state guarantees.

Fuchs has substance and is bold in his views, said one of his peers in the money management industry, who asked not to be identified speaking publicly on the matter.

“He has been right most of the time,” the person said. “But no one is God. No one can be right every time.”

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