* Hedge fund in China may grow to $61 bln in 5 yrs - E Fund
* Guotai, China Southern, Finch prepare new launches
* Hurdles include lack of expertise, shortage of hedging tools
By Samuel Shen and Nishant Kumar
HONG KONG, April 14 China is taking baby steps to develop its hedge fund industry as domestic money managers rush to roll out products armed with the country's one-year-old derivatives market, creating a fertile ground for its own version of industry legends George Soros or John Paulson.
More hedging tools and growing demand from its nearly half a million millionaires will fuel China's home-grown hedge funds, boosting the prospects for the $380 billion asset management industry in the world's second largest economy, home to the second highest number of the rich in Asia.
Early movers such as E Fund Management and Guotai Junan Asset have seen strong demand, while firms including Guotai Asset Management, partly owned by Italian insurer Assicurazioni Generali SpA , China Southern Fund Management and Rose Finch Investment are preparing to join the fray.
Greater China-focused hedge funds run from outside the mainland manage about $43 billion in total, mainly betting on Chinese shares listed in Hong Kong, according to data from fund tracker Eurekahedge, indicating the prospects for the industry in China.
"I feel that China's fund industry is at a turning point," said Liu Zhen, head of the index and quantitative investment arm of E Fund Management which launched a hedge fund last month. "Fund houses can no longer rely on the next bull market to grow. Quantitative and alternative investment will become an important driver of growth," he said. The industry could grow to manage as much as 400 billion yuan ($61 billion) over the next 3-5 years, said Liu, a former fund manager at U.S. hedge fund giant D.E. Shaw. FIRST STEP China's hedge fund industry came into being only last year when the government allowed index futures, short selling and margin trading, making it possible to offer such products.
Hedge funds tout their all-weather outperformance as a key factor that differentiates them from traditional funds which allows them to charge a performance fee of about 20 percent and management fee of 2 percent. Traditional funds only charge management fees.
In February, Guotai Junan Asset Management raised 500 million yuan in China's first hedge fund, after attracting investor subscriptions worth more than 1 billion yuan on the first day of launch.
Its president Zhang Biao, inspired by mathematics professor-turned-superstar hedge fund manager Jim Simens, aims to raise up to 5 billion yuan in new hedge funds, using the so called market-neutral strategy, under which fund managers target a fund beta, or market risk, of zero.
E Fund Management, one of China's biggest mutual fund firms, followed suit, launching a hedge fund through a private placement during the following month.
"There's enough money and investor demand in China to support the growth of the hedge fund industry," said John Yen, Hong Kong-based director at China Merchants Securities Co.
"I don't think it's difficult to raise several dozen million dollars for such products," he said.
About one fifth of the Chinese population owns 80 percent of the country's 30 trillion yuan worth of savings.
The world's fastest growing major economy is also home to 115 billionaires, according to the Forbes, who can turn into willing clients of hedge funds as they look to protect wealth. HURDLES AHEAD For hedge funds to prosper, Chinese money managers need to quickly develop investment expertise, hire global talent with the experience of short selling and require more liquid hedging tools to overcome the hurdles seen in markets such as India.
"All Chinese fund houses have been long-only investors, and when you turn to long-short products, you need different investment skills and philosophy," said Wang Jin, Hong Kong-based managing director at CSOP Asset Management.
He added that in overseas markets, it would often take three to five years for a star-trader-turned hedge fund manager to establish his or her reputation to raise big money.
Although derivatives were introduced in India about a decade ago, hedge funds have found it the toughest BRIC country to beat consistently in falling markets given limited opportunities to short.
In addition, fund managers in India, mostly from mutual funds, lack the experience in betting on falling share prices. [ID:nL3E7EP19S]
India-focused hedge funds have fallen more than the country's benchmark index in nearly one third of the 40 negative months recorded by the index since 2002, a study by the New York-based industry tracker HedgeFundNet (HFN) shows. Offshore China focused hedge funds have done better given their access to the sophisticated H-share market in Hong Kong. China has launched index futures based on only one index so far, the CSI 300 Index , and has restricted margin financing and short selling to a limited number of stocks, making it hard for hedge funds to fully hedge portfolio risks.
In addition, regulators ban investors from selling the stock on the same day of purchase, and discourage high-frequency trading of shares, making it tough for some hedge funds to execute arbitrage or other strategies, analysts said.
"At the current stage, there's not much hedge funds can do in China's market," said Lu Jiaxi, an analyst at fund consultancy Howbuy.
"Hedge funds could just be a new selling point for asset managers to raise money." ($1 = 6.533 Chinese Renminbis) (Editing by Vinu Pilakkott)