China's party conference raised policy risks that could lead to a lengthy period of valuation compression for its stocks

According to a co-founder of a 22-year-old Asia-focused hedge fund firm, China's party congress heightened policy concerns that could push its stocks into a prolonged period of valuation compression.

Indus Capital Partners' Byron Gill, drawing parallels between China and Japan in the 1990s, said the company's $729 million Pacific Opportunities Fund began to reduce its exposure to China stocks in the first quarter of 2021 and has spent much of this year net-short the nation.

Concerns over Chinese President Xi Jinping's growing hold on power have prompted global investors, like Chase Coleman's Tiger Global Management, to divest or cut their exposure to China. This year, a barometer of Hong Kong-listed Chinese companies has lost 33%, making it one of Bloomberg's worst-performing major stock indexes internationally.

Gill refined his talents as a Japanese stock analyst before directing Soros Fund Management's Tokyo office for 18 months and Indus' Japan office for the first seven years.

Japan's Topix Index has fallen 33% in local currency terms since the end of 1989, while the MSCI World Index has more than doubled. Gill criticised Japan for mistiming the introduction of restrictive fiscal and monetary policies, as well as stalling on measures to save the financial industry.

Gill also warned of the dangers of rising interest rates and an escalation of Sino-American hostilities over Taiwan.

The $184 billion Texas Teacher Retirement System is among the investors that have recently reduced their long-term target allocations to Chinese stocks in order to lessen the outsized China risks in their emerging market portfolio.

The continuous valuation compression in Japan harmed a generation of investors who chose growth businesses based on bottom-up earnings research. One of the survivors is Indus, whose oldest hedge fund focuses on Japan. From its start in 2000 until the end of September this year, the fund has returned 6.6% on an annualized basis.

Except for the first two years, its Pacific fund was profitable. Profits from both bullish and bearish wagers in China boosted the fund's 2022 return to an anticipated 1.6% by the end of October, according to an investor update seen by Bloomberg News. In comparison, the Eurekahedge Asia Long-Short Equities Hedge Fund Index fell 14%.

However, China is not condemned to follow Japan's lead, according to Gill. It will be determined by Beijing's policy decisions in industries including as real estate and banking.

Indus will continue to look for chances for bearish bets among Chinese businesses listed on international exchanges, while also looking for long-term holdings in the yuan-denominated domestic stock market.