Managers for the Quam China Focus Fund expect more mainland market volatility to come, even as a relative calm has prevailed following a turbulent -15.6% drop in the CSI300 last month.

“There is high degree of uncertainty surrounding the China economy, as there is a consensus that there will be no economic stimulus from the government,” says Jim Fong, portfolio manager for the Greater China-focused long/short equity strategy, run out of Hong Kong by Quam Asset Management.

Last month’s rocky trading conditions were triggered by an expected tightening of liquidity in China, with stocks of small banks bearing the brunt of losses. It has effectively diffused optimism that fuelled a bull market in February.

The Eurekahedge Greater China Hedge Fund Index was down -8.78% as of late last week, based on managers that had reported their June returns at the time. While they have performed better than the benchmark, early indications show that some managers may have been caught off guard by the turbulence.

Quam China Focus, which has an AUM of $30 million, had an estimated loss of less than -3% for the month of June, with year-to-date gains of about 38%.

The long-biased portfolio, which focuses on small- and mid-cap stocks of Chinese companies listed primarily in Hong Kong, had stocks that generated gains last month, says Fong.

Its portfolio constituents are companies that the fund forecasts will have 20% annual growth in the next three years, he notes. Finding stocks that fit the criteria isn’t easy, particularly given the fund’s viewpoint on China.

“We are quite pessimistic on the overall economic outlook,” says Fong, “but we see opportunities because of the depth of the market. It is changing from an export-driven economy to [one underpinned by] domestic consumption.”

Fong expects China healthcare and IT stocks to be among the sectors that will fare well, while exporters, banks, investment-related companies and insurance firms will likely suffer losses in future market routs.

US-based China hedge fund bears, which emerged during last month’s market dive, have comparatively apocalyptic predictions, with Kyle Bass of Hayman Capital predicting a “full-scale recession” in the mainland and Patrick Wolff from Grandmaster Capital proclaiming that “China is a crash waiting to happen”.

While Fong is expecting economic reform “which will be quite painful”, he doesn’t envisage a hard landing, as the central government is working to deflate market bubbles that were created over the past three years through easy credit. “They are trying to clean up bank balance sheets,” he notes.

China’s economic reformation follows a makeover that been undertaken by Quam China Focus last year, when it restructured its portfolio and investment style.

Founded in 2009, it had been mostly invested in index constituent stocks, resulting in highly correlated returns. In 2011, the fund was down 22%, but following its restructure last year, it returned 17% in 2012.

Its investor base largely comprises high net worth individuals, and has started to attract interest from institutions, says Fong.

The fund’s existing limited partners are aware of Quam’s expectation of future market volatility and understand how the portfolio has been geared in anticipation, he adds. “Some of them even have topped up their investments in our fund.”

"Companies are at a very low valuation, it is a good time for M&A, and interest rates are still quite low," says Fong.  "We think there will be quite a lot of corporate events in the second half [of this year] and we are looking out for these kinds of opportunities."