KGR Capital, a Hong Kong- and London-based fund of hedge funds specialising in Asia strategies, has launched a new fund of China hedge funds. It is a higher-risk product than KGRÆs other Asia funds of funds, given its China exposure, with targeted annualised returns of 20% and volatility in the range of 10%. It will begin with seed capital of $10 million, although the firm expects another $20 million or so to come in over the next few weeks.

Mark White, London-based CEO, says three years of back-testing suggests both that there is now scope for a China-focused product investing in good-quality managers, and that hedge fund managers do add value by protecting investors from downside risk.

The fund is skewed toward equities as there are no China fixed-income strategies that KGR could find, but within equity there are diverse strategies, including arbitrage, that allow for some degree of diversification.

Two of the top-10 holdings include Dragon Billion and Galaxy, two Hong Kong-based Greater China funds.

White acknowledges that, 18 months into a massive A-share rally, many investors havenÆt seen the need to pay fund-of-fund fees or, for that matter, to bother with China hedge funds. ôBut now we are in a different phase,ö he says, noting that Chinese authorities are trying to prevent a stock bubble from getting out of control. This is likely to include measures to liberalise domestic investments. ôThis will create arbitrage and other opportunities for hedge funds over the next 12 to 18 months.ö

Moreover, KGRÆs own back tests suggest that while the A-share index has now provided a net 24% return with 20% volatility over the past three years (remembering the first half of which included some mighty market tumbles), KGRÆs initial portfolio of managers delivered 22% for less than 10% of the volatility.

The fund of funds will include Greater China strategies and at this point only a small fraction of the underlying assets are directly invested in A shares. But the Greater China hedge fund universe now accounts for nearly 100 funds. White says this is nearly the size of the Japanese market. In asset terms, Japan funds are bigger, but are in decline, whereas China strategies are raking in assets. White predicts the two will reach parity sometime next year.

Like its other funds, the KGR Capital China Absolute Return Fund is domiciled in the Cayman Islands, charges 2/20 fees and is administrated by Citco. It is denominated in US dollars but euro and sterling classes will be available, with a minimum investment of $100,000. Structurally the only difference is liquidity: the China product deals monthly but requires a 90-day notice before redemptions. KGR Capital manages a total of $350 million in Asia-focused funds of hedge funds, including a $150 million Asia-Pacific version.