UPDATE 2-For some Asian hedge funds, market rout is sweet

* Vulpes, Tantallon funds gain about 4 pct each in August

* Vulpes saw gains by betting on volatility

* Buying bonds now is wrong, says Vulpes founder Diggle

* Asia-Pac (ex-J) mutual funds' NAV down 7.3 pct on average -Lipper

* Top Asia-Pac (ex-J) fund run by Mobius sees $2.2 bln portfolio hit (Adds further quotes)

By Nishant Kumar

HONG KONG, Aug 9 (Reuters) - Asian hedge funds Vulpes, started by industry veteran Stephen Diggle, and Tantallon Capital are emerging as winners in a volatile August that has wiped more than $3.8 trillion off global stock markets.

Diggle, who made a fortune during the financial crisis, told Reuters his long Asian volatility and arbitrage fund LAVA gained about 4 percent in the first six trading days of the month.

The fund's bets on volatility going up paid off as the U.S. government struggled to piece together a deal to address its fiscal problems and S&P cut its AAA rating.

Tantallon Capital, founded in 2003 by former Morgan Stanley wealth management executive Alex Hill and Nicholas Harbinson, who earlier worked at Merrill Lynch and Goldman Sachs , gained 4.15 percent in its flagship fund last week, according to a letter to investors seen by Reuters.

On the other hand, some of the biggest Asia ex-Japan-focused mutual funds from firms such as Fidelity, JP Morgan Investment Management and Franklin Templeton lost more than 10 percent this month, according to data from Thomson Reuters Lipper.

By comparison, Asian shares as measured by the MSCI index of Asia-Pacific stocks outside Japan , plunged 8.7 percent last week and extended losses to 11.8 percent on Monday.

"Everyone is just trying to reduce their exposure to equities principally in a very thin August market and that has caused very significant volatility," Diggle said.

"We are basically long risk and that's going higher," said Diggle, who made $2.7 billion for investors between 2002 and 2009, mostly during the financial crisis at his previous hedge fund firm Artradis.

Singapore-based Artradis shut earlier this year after double-digit losses in its main funds in the prior two years.

Vulpes and similar hedge funds bet on volatility using options. In times of low volatility, such as the second quarter of this year, the premium required to buy out-of-the-money options falls, rendering them cheaper to buy.

Funds looking to hedge portfolios against rare but highly risky 'Black Swan' events or funds betting markets are underpricing volatility could take advantage of low prices to load up on such options. And as volatility shot up last week, such bets paid off.

The VIX, a key measure of investor anxiety, has been rising and rose to 48.0 on Monday, its highest close since March 2009.

But not everyone thinks such aggressive plays will continue to reward.

Aoifinn Devitt, portfolio manager of the City Financial Asian Absolute Growth Fund, said hedge fund managers of all kinds should be trimming risk, raising cash and positioning themselves for continued market turbulence.

She warned against purely long volatility strategies at this juncture, which she believes are likely to be costly to implement and prone to the dreaded 'whipsaw' effect when current trends reverse.

"This is not a fail-safe strategy, particularly in Asia, which will suffer acutely from any flight from risk and where shorting is far more difficult to execute than in broader, more liquid markets," Devitt said.

"Our portfolio has an average net exposure of 40 percent, which will contemplate some market direction, but should provide some cushion against the sharp moves to be expected from a long only portfolio."

The Cayman Islands-domiciled fund of Asian hedge funds has delivered 2.68 percent in the year to date, data from Thomson Reuters Lipper shows, beating peers in its MSCI AC Asia ex-Japan benchmark by 13 bps.

Vulpes manages $185 million in assets. Tantallon manages more than $300 million.

The Macquarie Asian Alpha Fund, a $1.5 billion market-neutral long/short Asia-focused hedge fund from Macquarie Group , was up 0.4 percent last week, according to a person with direct knowledge of the matter.

BONDS ARE WRONG BET

Diggle said although Asian equities had been "punched in the head really hard", investors believed the storm would pass because while short-term volatility jumped over the last six sessions, longer dated volatility was up very little.

"Where we think markets are getting it wrong is that the immediate reaction that people have to low growth numbers, you sell equities and you buy bonds ... buying bonds now is completely the wrong thing to do," he said.

He said his firm would rather bet on increased weakness and volatility in government bond markets than on equities which looked okay at current levels.

Diggle is expecting most Western governments to lose AAA status and investors to question solvency of government bonds.

"I don't think that lending money to governments, if they look like becoming insolvent governments, is a great idea."

With no options to hedge the downside, sliding markets have hammered the net asset values of mutual funds. Mark Mobius' $18.5 billion Templeton Asian Growth fund lost about 11.9 percent of its net asset value, or about $2.2 billion.

Big losers also included the $1.4 billion JPMorgan Asia Equity Fund (-13.6 percent) and the $1.86 billion Fidelity Emerging Asia Fund (-13.5 percent). (Additional reporting by Sinead Cruise in London, Editing by Muralikumar Anantharaman and Dean Yates)