Having been researching China hedge funds since 2004, Singapore-based research firm GFIA has redeemed its discretionary holdings of mainland-run managers, apart from "a small handful of, in effect, western firms" in Shanghai. It has largely shifted its coverage to western-trained managers based in Hong Kong.

Despite finding some good and operationally sound managers, GFIA says it has also failed more Chinese managers at the due-diligence level than any other sub-group in its global universe. It has also had to redeem two discretionary holdings of China managers after red flags were raised in its monitoring process, says the firm in its monthly Research Insights report, published yesterday.

GFIA concedes that "rear-view risk management" is not ideal, but says it seeks to make sure its risk management looks at "where the risks might be next, rather than where they just popped up last".

The consistent theme of managers with People's Republic of China (PRC) 'DNA' is of "a lack of fundamental transparency and openness", says GFIA, citing occasions where hedge funds would not reveal the identity of fund backers or the background of portfolio managers. After five years' involvement in the Chinese hedge fund industry, the firm has concluded that a fiduciary investor runs too much risk investing through PRC-managed entities.

"Our thesis -- and this is speculation -- is that there is no internalised culture of business or fiduciary ethic in the PRC," says the GFIA report. "One generation ago, there were virtually no institutionalised private businesses. Now, there are, but the principals running these businesses did not grow up, professionally, within an environment that demanded fiduciary responsibility."

However, the relatively small number of China hedge funds combined with huge investor interest in the country means there will be no shortage of investment in the sector, especially since "absolute performance has been compelling", says GFIA. The firm cites several funds with returns of over 100% for 2009, including Greenwoods Asset Management's Golden China Fund, an equity long/short strategy that gained 182.40% last year.

A further issue with PRC-linked managers is the contrast between their approach and that of the rest of GFIA's universe. "We've often commented that managers based in Asia and the other parts of the world in which we invest, are generally very transparent, open, and investor-friendly," says the firm. "They have to be, in order to generate comfort with investors who are typically based in Europe or North America."

The report cites India and Latin America managers as notable examples of those offering stronger governance, openness and transparency than Chinese firms.

Meanwhile, in December, GFIA launched a wealth-management service targeting sophisticated pools of private wealth, having been approach last quarter to set up and run a new family office. GFIA will act as a fiduciary agent on clients' behalf, from initial structuring through cash management, portfolio investment, deal/acquisition due diligence and philanthropy, managing external service providers on behalf of clients.