Why Hedge Funds Are Betting Big on Alibaba and Baidu for 2024

Key Points

• Historical valuations for Chinese technology stocks are at an all-time low compared to U.S. peers, opening an asymmetrical opportunity for investors.
• Alibaba and Baidu are attracting hedge fund interest despite geopolitical risks, and retail investors are following suit.
• Alibaba's primary listing in Hong Kong could attract billions of new investors, particularly Chinese citizens and institutional buyers, potentially boosting its valuation and setting a precedent for other Chinese companies to follow.

Many of the world's most influential hedge funds use relative value strategies, which involve going long on undervalued stocks and shorting overvalued stocks. This approach is part of long/short equity strategies, a common practice in hedge funds to manage risk and maximize returns regardless of whether the overall market is rising or falling.

Today, because of 13F filings, retail investors are able to track which stocks hedge funds are buying or selling — which can help them identify potential undervalued opportunities.

Many fund managers, and not just hedge fund managers, have found enough upside to justify allocating capital toward Chinese stocks despite all the fear and negativity surrounding them today. The risk-to-reward profile for the technology sector seems to favor names in the Chinese market over their U.S. counterparts. While the United States has the FANG (referring the most prominent and high-performing American technology companies: Facebook/Meta, Amazon, Netflix, and Google/Alphabet), in China, it's Alibaba, Tencent, and Baidu.

Despite concerns about regulatory pressure, geopolitical tensions, and economic uncertainty in China, some of Wall Street’s best fund managers are making contrarian bets on e-commerce and cloud computing giant Alibaba Group NYSE: BABA and on China’s version of a broad search engine and artificial intelligence processor Baidu Inc. NASDAQ: BIDU. 

Record Lows Shift the Risk-Reward Scale in Favor of China Bulls

Many believe that a stock or index is cheap relative to comparables for a reason. They might be right in this case, and some of the fears in China could hurt its tech sector further. However, long-term investors and traders should focus more on the risk-reward profile.

The forward price-to-earnings (P/E) ratio for the Chinese tech names is at an all-time low compared to the forward P/E ratio currently placed on the Invesco QQQ NASDAQ: QQQ, which is designed to track the performance and holdings of the NASDAQ 100 index.

For comparison, the top three holdings in the QQQ are Apple Inc. NASDAQ: AAPL, Microsoft Inc. NASDAQ: MSFT, and Nvidia Co. NASDAQ: NVDA. These stocks trade at an average forward P/E valuation of 30.5x today, much higher than their historical valuations of 20.0x on average.

The top holdings in the KraneShares CSI China Internet ETF NYSE: KWEB, a popular choice for investors seeking diversified exposure to Chinese internet companies, are Tencent Holdings Ltd. OTCMKTS: TCEHY, Alibaba, and JD.com Inc. NASDAQ: J.D.. The average forward P/E valuation for these is a much lower 9.9x.

In straightforward terms, the risk is more significant with the U.S. tech names since they are now much higher than their historical valuations. In contrast, the risk is lower for China now that these names are below historical multiples.

Alibaba: Making Headlines for All the Right Reasons

Many prominent hedge fund managers, including Michael Burry, David Tepper, and George Soros, hold large positions in Alibaba. 

So why all the bullishness? Alibaba recently announced that it will offer a primary listing in the Hong Kong market, which means a few things.

First of all, if the listing — free from U.S. market influence — turns out to be at a higher valuation than the New York listing, billions of buyers will flood in to close down this arbitrage opportunity.

Second, this primary listing now allows millions of Chinese citizens to buy stock directly in one of the country’s blue-chip technology companies. Other institutional buyers, like the iShares MSCI China ETF NASDAQ: MCHI, might be obligated to double down on this holding as well. If Alibaba's primary listing goes well, it could serve as a path for others to follow suit.

Knowing this, analysts at Susquehanna have kept a price target of up to $130 a share for Alibaba stock, calling for a possible 60.1% upside from its current price.

Baidu: The Moonshot in Michael Burry's Portfolio

If Alibaba's primary listing goes well, it could serve as a path for others to follow suit, creating a path for more Chinese companies to attract local investors. This is the angle Burry is hoping for in Baidu, as his fund Scion Asset Management currently holds a 75,000-share position.

As of August 2024, Primecap Management Co. is leading the way in buying, with a recent boost in Baidu stock holdings by 17.2%.

This addition brings their net investment up to $1 billion today, or 3.4% ownership in the company, acting as another vote of confidence for retail traders to lean on.

Wall Street acknowledges the inherent upside. Analysts at Citigroup have landed on a $155 price target for Baidu stock today, daring it to jump by up to 91.3% from today's price.