China onshore hedge fund managers are showing signs of diversification, with some planning to set up an offshore presence in Hong Kong, according to Skybound Capital.

The Cape Town-based firm funds a mainland-focused China Red fund of hedge funds, with $20 million in AUM. It returned about 6% in 2012 – a bumpy year for China managers, having experienced a strong average performance in January and February before slumping in the months leading up to September, by the Eurekahedge Greater China Hedge Fund Index.

“Some of the [China] hedge fund managers suffered,” notes Theodore Shou, Skybound’s chief investment officer, based in Hong Kong. “At the beginning of the year they entered the market with very low net exposure because they were scared," says Shou. "Some of them got caught in May when they finally decided to up-weight a bit.”  

In early 2012, China Red was merged with Skybound’s Dragonfly Asia Pacific Fund – a FoHF which had a regional mandate.   

“Frankly our investors are more interested in the China story,” says Shou. “Most of the investors that were invested in the Dragonfly fund also had a position in the China Red Fund.”

At the moment, China Red’s investments in mainland-focused hedge funds are strictly through offshore managers. They typically have an office in Hong Kong and operate a Caymans-registered vehicle that enables them to raise capital outside of China.

“Many of them have exposure to both onshore and offshore markets through their portfolios,” says Shou. “A lot of them also have a physical presence in China, such as offices and research hubs.”

Clifford Warren, founder and chairman of Skybound, adds: “Quite of a few of the groups we deal with are more based in China than they are here [in Hong Kong]. And most of them run renminbi[-denominated] funds as well, using a complex trust structure.”

Shou says he knows of a few onshore mainland managers that are planning to set up new offices in Hong Kong to launch offshore funds. Offshore China hedge funds are primarily long/short equity strategies, but there are signs of diversification among newcomers.

“For example, I was talking to a potential manager onshore in China who’s trying to launch a quant fund [in Hong Kong],” says Shou. “We may possibly see more credit managers as well, who focus on offshore markets.”

There are already a number of China onshore fixed income hedge fund managers, with many of them said to be levered 10-times, with leverage provided by sources that include mainland commercial banks.

Shou oversees Skybound’s Hong Kong office, which was launched in late 2011. The firm oversees AUM of about $300 million, putting it among the smaller multi-product managers in the sector.

Despite a trend of consolidation among FoHFs, the firm has no plans to merge and will instead continue its niche focus on China and Africa.

“We see probably greater opportunity,” says Cape Town-based Warren during a recent visit to Hong Kong.

Shou points out that consolidation translates into less competition. “It’s not that we are afraid of competition. It’s good news to investors because now they have an easier decision process.”