China is a welcoming place for smaller fund managers seekimg out new inflows with its growing ranks of high net worth individuals (HNWI) looking for higher returns. “In China, the market is less sophisticated so HNWIs are not looking for billion-dollar funds. They are prepared to invest in smaller managers and they are also prepared to take chances on people,” says Paul Smith, managing director of CFA Asia-Pacific. The potential for a hedge fund industry boom in China is on the horizon. “There is clearly a demand for hedge fund strategies because the traditional world is not producing the sort of returns that they want,” he adds. “You can see that demand in the explosion of the [Chinese] wealth management world.”

For Andy Seaman, chief investment officer at Stratton Street Capital, China and more specifically the renminbi offer investors new opportunities for growth. As the head of its renminbi bond fund, he aims to capture the appreciation of the Chinese currency. “The Chinese bond market can be a very significant bond market that could soon rival the [US] treasury market,” he predicts.

At US$53.6 billion, the Greater China hedge fund industry is in its infancy when compared to the US$965 billion AUM of the US market. However, homegrown firms such as Hillhouse Capital Management (AUM US$7 billion) and Greenwoods Asset Management (AUM US$1.1 billion) have started establishing themselves on a global scale.

To foster this industry potential, China still has to create a highly-developed financial market that is able to cope with a range of different investment strategies. “Functioning derivatives market, structured products, insolvency laws, take-over laws, these pieces aren’t in place [yet] in China, so the range of strategies you can access in China is relatively narrow,” Smith says.

Firms may experience difficulty in gaining traction also due to the limited number of service providers (fund administration houses, legal firms and accounting firms). Compared to the offshore markets, the cost of setting up hedge funds in China for now is likely to be higher. But just as the industry grew from US$38 billion in 1990 to where it is today, the size of China’s hedge funds’ market is likely to grow rapidly in the coming years.