A Star Investor's Big New Trade

Hedge fund manager Bill Ackman made waves in the financial community yesterday by announcing that he was making a very bullish bet on the Hong Kong dollar.

We'll get to the details behind the strategy in a bit. The real "Aha!" is this: Even after the market's recent sharp decline, one of the world's leading stock pickers is, evidently, not that interested in buying stocks.

Back to That Trade

With its value currently pegged to the U.S. dollar, the Hong Kong dollar could potentially be an inflation buster (as well as an attractive return instrument) provided Hong Kong unpegs its peg -- one put in place to provide stability in a relatively small economy.

So why would Hong Kong do such a thing?

The reason is that by pegging its currency to the dollar, Hong Kong effectively adopts our country's monetary policy -- one that today is characterized as "highly accommodative." For those who don't speak Federalese, that means money is cheap because the risk of recession, in the eyes of policymakers, is greater than that of rampant inflation.

Hong Kong, however, has exactly the opposite problem. Because of its proximity to fast-growing China, Hong Kong's GDP growth rate was a robust 6.8% in 2010.

Put together cheap money with GDP growth of that magnitude and you get torrents of inflation. That has manifested itself in Hong Kong in rapidly rising food and housing prices. The most recent reports show Hong Kong's inflation rate accelerating close to 8%.

Heads I Win, Tails I Don't Lose

Sponsored Links

Unless Hong Kong unpegs from the dollar and potentially repegs (at a stronger rate) to a more appropriate currency, such as the Chinese yuan, rampant inflation becomes an uncomfortable and unsolvable problem.

So what's the upside for Ackman's bet on the Hong Kong dollar? The seeming appeal of this trade is that there are two potential outcomes:

• The first is a flat return for the Hong Kong dollar -- which isn't a terrible proposition in this volatile market, particularly when that's what one would get anyway sitting in cash. (If you use call options on the Hong Kong dollar, as Ackman suggested in his presentation, you could lose the relatively small amount you pay for those options if the Hong Kong dollar doesn't get repegged.)

• The second is that Hong Kong changes policy and the trade skyrockets in value. No matter what the probabilities -- and the latter is a very low probability event given that Hong Kong's political leadership is flatly opposed to the plan for a variety of good reasons -- this is seemingly a favorable risk/reward trade-off.

If Hong Kong unpegs, Ackman makes a lot of money. If not, then Ackman's cash would sit in Hong Kong dollars earning the same paltry interest rates he would earn in the U.S. It's the consummate "heads I win, tails I don't lose" opportunity.

While it is an interesting trade, it is not a novel one. My Motley Fool colleague Michael Olsen reported that Michael Kao of Akanthos Capital made the same pitch at an investing conference back in May. But Michael Kao is not Bill Ackman, so now the media, bloggers, and other financial gadflies are all atwitter.

The Global View

Critics have gone after Ackman for all of a sudden turning from stock picker to macroeconomic strategist, but I think that's unfair. This trade is more game theory than economics and the chance is some magnitude greater than zero that Hong Kong does unpeg. As a small portion of your portfolio, perhaps you, too, should think about stashing some cash in a Hong Kong savings account.

That said, if there's an implicit indictment of Ackman in this idea, it might be that it's evidence that he doesn't have a whole lot of other good ideas at present. After all, there's opportunity cost in sitting on an investment that is most likely to do nothing for five years.

Get Tim Hanson's top global stock picks by joining Motley Fool Global Gains. Tim's "Global View" column appears every Thursday on Fool.com. Tim Hanson is the Fool's lead international advisor and co-advisor of Motley Fool Global Gains.