HONG KONG Capital-starved Asian hedge funds may have got the lifeline they've been waiting years for - investors from China, some of whom are willing to risk very large sums of money.
This new source of capital is a potential game changer for an industry that has been dependent on the whims of U.S. and European fund flows.
It may also represent a key turning point in the movement of Chinese wealth offshore as the world's second-biggest economy becomes more flexible about inbound and outbound investments.
Up until recently Chinese capital was barely noticeable, industry sources say. But this year more than half a dozen firms in Hong Kong, mainly investing in the Greater China region, have gathered at least $500 million from mainland investors, calculations based on information provided by sources show.
Spurring Chinese interest has been a strong performance by Asian hedge funds this year, as well as market reforms and the sense that high-yielding wealth management products in China are becoming unsustainable as they draw scrutiny from authorities.
Investors include Zhang Lei, founder of Asia's biggest hedge fund Hillhouse Capital, members of China's wealthy elite and Chinese private equity firms. There is also at least one listed firm - gold producer Zijin Mining Group Co Ltd (601899.SS) which set up its own fund, providing $100 million in capital.
"There is clearly light at the end of a very long tunnel for Asian hedge funds in the form of indigenous capital," said Jay Moghe, Asia Pacific head of alternative funds services sales for Deutsche Bank.
"Investments from China could help to set the industry on a sustainable path to recovery."
While much of the world's hedge fund industry has recovered from the global financial crisis, Asian hedge funds have not -hampered by poor performances until last year, as well as their small size.
More than three quarters manage less than $100 million, too little to win big ticket investments from U.S. and European financial institutions such as pension funds.
As of end-September, Asian hedge funds managed $141 billion, still a fifth below pre-crisis levels and just 7 percent of the global total, according to industry tracker Eurekahedge.
Industry insiders say Asia's hedge funds need to grow to around $200-$300 million in assets under management to attract institutional money. To get there, they first need money from rich individuals and other seeders such as investment offices run by wealthy families.
That gap has so far been left open by Asian investors.
Japan, home to the world's second biggest population of the wealthy, should be a natural source of such capital, but industry experts say many Japanese investors are reluctant to invest even in equities and often just keep their fortunes in deposit accounts.
Those who invest in hedge funds almost entirely go to large U.S. and European funds for greater diversification away from their home base assets, said Edward Rogers, head of Tokyo-based Rogers Investment Advisors.
But wealthy Chinese don't have the same access to more developed retail savings and investment industries found in Japan, South Korea and Taiwan. That spurs them to look at hedge funds and when they do, they prefer working with local managers with whom they have personal relationships, sources say.
And while China's millionaires - some 643,000 in 2012, according to a Capgemini and RBC Wealth Management report - may only number a third of Japan's, some appear willing to bet big.
Sources said that whereas the small set of Asian millionaires who do invest in local hedge funds typically allocate a few million dollars, the money flowing from China often comes in larger helpings - in some cases more than $50 million from just one backer, enough to start a hedge fund.
Steve Bernstein, chief executive of hedge fund platform SinoPac Solutions, told Reuters he met two mainland Chinese family offices last week which are looking to invest at least a combined $30-35 million into Hong Kong-based funds.
But some participants urge caution, noting that moving money out of China is still very much a gray area and that wealthy Chinese could easily row back on hedge fund investments on any signs that authorities were against the outflows.
"It's potentially a very substantial source of capital but equally it's probably quite a scary one to build a business," said Peter Douglas, founder of hedge fund consultancy GFIA.
"We probably understand the drivers of U.S. and European money better than the drivers of Chinese money."
In addition to money flowing into established funds, the push is also feeding off the ambitions of experienced managers that have established track records at well known global hedge funds and are keen to start their own businesses.
Cong Li, a former chief investment officer at Mirae Asset Global Investment, has said he is planning his own fund, helped by Chinese investments. Serenity Capital, run by Wang Chan, a former partner at Tiger Global Management, won the backing of Zhang Lei, the founder of Hillhouse Capital, AsiaHedge reported.
Encouraging this new flow of funds has been a near 16 percent outperformance by China-focused long/short equity hedge funds over the MSCI China index .MSCICN for the year through end-October, the best outperformance in five years.
Assets of Greater China-focused funds rose to $12.9 billion in October, the highest level on record and 16 pct higher than the pre-crisis peak, according to Eurekahedge.
Reforms that have loosened some investment rules over the past few years are also providing a tailwind and are likely to continue to do so after China said this month that the market would play a decisive role in the economy.
Observers add that Chinese capital will likely spread to regional funds in years to come, even if Chinese managers continue to gain the largest share.
"If you look 5 to 10 years forward, then in conjunction with more broader liberalization of currency rules, we are clearly going to see a huge export of capital from onshore China," said Graham Seaton, head of Asia Pacific prime brokerage for BofA Merrill Lynch.
(Editing by Edwina Gibbs)