* China hedge funds lost 17.9 pct in June-Aug
* Ariose, Tairen China funds among few winners
* Inflows fade, fears mount on capital outflows
By Nishant Kumar
LONDON, Sept 4 (Reuters) - China-focused hedge funds suffered record losses in the past three months and were overtaken by their Japan-themed peers as this year's best performers, leaving them at risk of a surge in redemptions.
China hedge funds, which collectively manage $21.5 billion in assets, posted a 17.9 percent loss for June-August, the worst ever for a three-month period, amid a rout in Chinese stock markets, data from hedge fund tracker Eurekahedge shows.
Some managers were caught out by the extent of the selloff in China, re-entering the market prematurely.
"Many managers thought the collapse had nearly ended when it was just midway through and they increased exposure significantly then hammered," said Theodore Qi Shou, chief investment officer of Hong Kong-based Skybound Capital, who invests in hedge funds.
Funds' failure to protect investors' capital could see them face fresh pressure to justify their higher fees.
"I certainly expect that many investors will be rethinking their China strategy," said Peter Douglas, founder of Singapore-based hedge fund consultant GFIA.
"Being the world's second-largest economy and a geopolitical powerhouse is all well and good, but this is, in capital market terms, still a fairly early stage emerging market and I think a lot of investors had forgotten that."
Losses over the past three months eroded funds' gains earlier in the year. Chinese funds were up only 3.6 percent year to date by the end of August, overtaken by Japan hedge funds which returned 6.3 percent in the first eight months of 2015, making them the best-performing regional group globally, Eurekahedge said.
There were exceptions, such as the Ariose China Growth Fund and Tairen China Fund, both of which made money betting stocks would fall.
China's stock markets are down nearly 40 percent since mid-June and Chinese funds of all stripes have been hammered by the rout that saw hundreds of stocks suspended, curbs on short selling and guidance to buy and not sell from the government, which raised questions over its reform efforts.
As a result, investor interest in China hedge funds has already started to fade.
Eurekahedge estimates net inflows fell to $376 million in July, from more than $800 million in May.
Exact withdrawals from hedge funds in August will be known in the coming months as these funds allow only monthly or quarterly redemptions.
In the broader industry, investors withdrew a net $2.8 billion from offshore China-focused equity mutual and exchange traded funds in July, data from industry tracker Thomson Reuters Lipper showed.
"It will take time for investors' and fund managers' confidence in China to return to positive and stable sentiment, especially with some managers having had to suspend fund investments and redemptions," said Miranda Ademaj, chief executive of hedge fund investor Skënderbeg Alternative.
Among funds hardest hit was the Quam China Focus hedge fund. It was up 60 percent by the end of May but is now nursing a 1.2 percent loss this year after sliding almost 21 percent last month through Aug. 28, data seen by Reuters showed.
Other losers in August included the $2 billion Golden China Fund, which lost 8.9 percent, and the Zeal China Fund, which fell 4.6 percent, the data showed.
A bias towards small and mid-cap stocks, a failure to hedge and some forced unwinding of short bets on signals from local authorities contributed to the poor performance, said Shou at Skybound Capital.
Those who bet on prices falling early won out.
They included specialist short-sellers Ariose China Growth Fund and Tairen China Fund, which both gained 8 percent through July, letters to investors seen by Reuters showed. (Editing by Simon Jessop and Susan Fenton)