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China-focused hedge funds buck market doldrums

Wednesday, 18 Dec 2013 | 5:55 PM ET
What's behind the rise of China hedge funds?
Wednesday, 18 Dec 2013 | 8:22 PM ET
CNBC's Julia Wood and Oriel Morrison discuss why Chinese-focused hedge funds have managed to avoid Shanghai's market gloom.

Despite another disappointing year for Chinese equities, mainland-focused hedge funds have produced solid gains, outperforming their benchmark equity indexes by a wide margin.

Greater China-focused hedge funds are up 17.8 percent in the year through November, according to data from research firm Eurekahedge, far surpassing the Hang Seng Index and Shanghai Composite. The Hong Kong market is up just 5.4 percent over this period, while the mainland market is down 2.1 percent.

This is in stark contrast with Japanese hedge funds, which have returned 24.1 percent in the year through November - lagging the Nikkei 225's over 50 percent rise. And, European-focused hedge funds which are up just 7.4 percent, trailing Germany's DAX and the U.K.'s FTSE 100, which have risen 23.6 percent and 12.8 percent, respectively.

(Read more: No letup on risk for hedge funds this December)

The majority of Greater China-focused hedge funds run an equity long-short strategy, which has worked well in the current market environment where there is disparity in the performance of sectors, say analysts.

The long-short strategy seeks to profit from stock gains in the long positions and price declines in the short positions.

Peter Parks | AFP | Getty Images

For example, fund managers have benefited from long positions in the mainland healthcare and telecom stocks, and short positions in financial stocks, said Mohammed Hassan, analyst at Eurekahedge. He adds that the cost of shorting stocks has been declining alongside liberalization in the country's financial market.

Paul Waide, co-founder of Shanghai-based Amalfi Capital, an investment fund focused on China, said another reason behind the outperformance of mainland-focused funds is that many own shares of Chinese companies that have listed in the United States this year and performed very well.

(Read more: Hedge funds bet against Manchester United)

Shares of Qunar, the Chinese travel-booking service controlled by Baidu, for example, rose 89 percent on their debut on November 1.

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Waide's Amalfi Capital Fund I, whose fund places an emphasis on opportunities in China's technology sector, is up 19 percent year-to-date.

While returns by Japanese and European hedge funds are trailing behind their equities indexes, experts say their performance is respectable.

Many Japan-focused hedge funds are U.S. dollar denominated, thus the depreciation the yen is the key factor behind why they are trailing the benchmark index, said Waide. The yen has fallen almost 19 percent against the U.S. dollar this year.

(Read more: Hedgeholdings soar despite returns trailing behind)

Alex Mearns, CEO, Eurekahedge added that hedge funds should not be capturing all the market gains as it would be risky.

"When the market goes up a lot, hedge funds of course should be producing positive returns, but they shouldn't be capturing all the gains. They should have short exposure to hedge out some of the risk if the market turns quickly. It would be highly risky to be all in the market."

—By CNBC's Ansuya Harjani; Follow her on Twitter: @Ansuya_H

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