(Bloomberg) — The founder of Hong Kong’s Brilliance Asset Management Ltd. said he made a mistake in underestimating the impact of Beijing’s reforms in the education sector, but struck an optimistic note about two players in an industry many are writing off.
Shi Lin’s Brilliance has invested in the sector, which saw its fortunes plummet after China unexpectedly banned certain after-school tutoring companies from making profits, going public and hosting classes on weekends and holidays. Shares of Chinese technology and education stocks began tumbling last Friday on news of the policy turn, spurring a record three-day drop in a gauge tracking the biggest U.S.-listed Chinese firms.
“It’s my mistake to underestimate the policy impact and the impact to investor sentiment,” Shi wrote in emailed commentary seen by Bloomberg that was sent to investors after the new rules were announced on Saturday. Still, he said, he thinks the fund manager’s understanding of the fundamentals is “right in the long term.”
Shi’s Greater China-focused hedge fund, Brilliant Partners Fund, meanwhile recorded an estimated loss of more than 12% this month as of July 23, according to people familiar with the matter, who asked not to be identified as the information is private. It’s unclear what drove the declines, but they came as a rare setback for the fund manager, which had $6.8 billion of assets in hedge and long-only funds at the end of January, according to a regulatory filing.
The fund lost 6.6% in the first half, according to a newsletter seen by Bloomberg News. A Eurekahedge Pte gauge that tracks the monthly performance of Greater China stock-focused hedge funds rose 7.1% in the six months.
In a response to questions, a representative of Brilliance said by email that the information was “incomplete and incorrect, and highly prejudicial,” without providing details.
A separate Brilliance long-short fund, regulated under the European Union’s UCITS directive, that can be sold to retail investors, lost 5.7% in the week through July 23, extending this year’s loss to nearly 12%, according to data compiled by Bloomberg.
China’s sweeping clampdowns on everything from financial technology to e-commerce, ride-hailing, food delivery and now education have hurt funds focused on investing in the nation’s companies.
A deepening selloff in Chinese stocks spread to global bond and currency markets this week as investors worried how much further the regulatory onslaught would go. The authorities stepped in to reassure investors late Wednesday, sparking a recovery in Chinese equities in the U.S. that continued into Asia, though benchmark indexes are solidly down this month.
Hedge funds focused on fundamental stock-picking for China are headed for their worst month on record, according to Goldman Sachs Group Inc.’s prime brokerage team.
Beijing’s latest reforms for the education space will fundamentally alter a business model that created the $100 billion edtech sector.
The regulations ban tutoring related to the school syllabus on weekends or during vacations. School syllabus tutoring providers also have their access to foreign capital cut off. Companies can’t give online or academic classes to children under 6, a segment of the population that had increasingly been pushed to start studying early.
Despite this, Shi told investors he remained bullish on two stocks over time — TAL Education Group and New Oriental Education & Technology Group Inc. TAL slumped 92% so far this year, while New Oriental has dived 88% in U.S. trading.
Shi, a former Hillhouse Capital employee, has steered the Brilliant Partners Fund to a cumulative 403% gain over the eight years through June, according to the newsletter seen by Bloomberg News. Before this year, it suffered a lone annual loss of 5.4% in 2018. Fund performances can have minor variations, depending on share classes and fees.
Brilliant Partners was named the best Asian billion dollar hedge fund in Eurekahedge Pte’s 2020 awards. Data provider Preqin ranked it the second-best-performing Asia-Pacific-focused hedge fund by annualized net return between 2015 and 2017.
Shi expects a “massive amount of bankruptcies” among smaller after-school tutoring companies as a result of the new rules. The exit of 70% of such firms, which currently meet about 70% of market demand, would consolidate the industry in favor TAL and New Oriental, he wrote in the emailed commentary. New venture capital-backed competitors will also change their business scope and exit, he added, citing Yuanfudao and Zuoyebang as examples.
Brilliance held 5.6 million TAL shares as of March 31, according to its latest regulatory filing.
TAL and New Oriental will see a 20% to 30% revenue drop in 2022, before resuming steady growth, taking into account the consolidation and measures taken on their part, Shi wrote.
Analysts remain divided on whether the rules that ban IPOs, foreign capital and profit-making apply to institutions that provide school curriculum tutoring to high school students due to vague wording in the policy notice. If such activities are exempt, some companies could benefit from consolidation as Shi suggested.
The rules also leave firms room to continue making money on other businesses such as overseas test preparation and adult English proficiency.
A representative for TAL did not respond to requests for comment, while New Oriental declined to comment.
Online tutoring leader TAL, in particular, will report “very strong net profit growth” from now on, Shi wrote. There is “hard demand” for after-school tutoring, he said. “This policy has created the perfect competitive landscape for TAL and EDU to further grow.”
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