NEW YORK (CNNMoney.com) - U.S.-China trade relations may be fraught with controversy thanks to a large trade deficit, the outsourcing of jobs and concerns about human rights abuses in the country.

But China's economic growth has inevitably whipped up investor interest as well, with hedge funds leading the charge.

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Some investors, concerned about corruption and a lack of regulatory oversight, are fearful of diving directly into the growing Chinese stock market.

But hedge funds, which are private investment pools for wealthy individuals and institutional investors, began setting up shop in the region years ago, attracted by the area's high return potential. These funds seek to profit from market inefficiencies, which are becoming harder to find in highly liquid and efficient markets such as those in the U.S. and Europe.

These funds may require greater risk tolerance than their U.S. counterparts do, but the returns can be worth it. China-based hedge funds gained 16.8 percent through March of this year, according to publishing and research firm Hedge Fund Intelligence (HFI).

Estimates for the U.S. hedge fund market range from $1.2 to $1.5 trillion, but assets in Asia-Pacific hedge funds now account for $115 billion, according to HFI. Assets in Hong Kong-based hedge funds have jumped from $1.8 billion in 2000 to $15.9 billion in 2005.

Sandra Manzke, a hedge fund industry veteran who last year founded Maxam Capital, which runs investment products that are based on indexes of hedge funds, said that as the Chinese government continues to broaden its financial markets to foreign investors, hedge fund interest in the region has climbed.

"We really are becoming a more global economy," she said. "You'll start seeing a lot more interest in China as they move into allowing more foreign ownership."

China's markets can be daunting to new investors, with its multiple share classes and markets scattered across different parts of China. But it has become a more rewarding investment this year, with the Shanghai Stock Exchange Composite Index climbing 22 percent for the year to date.

Investors still cannot short the stocks of companies based in mainland China, but hedge fund managers have gotten around this by making long investments in mainland China companies and shorting Hong Kong and Taiwan-based companies, because shorting is legal in those markets.

Many hedge fund managers invest in a "greater China" basket of stocks, in addition to commodities. That means they buy stocks listed on the Shanghai and Shenzhen indexes as well as Taiwan and Hong Kong-listed stocks.

Buying commodities such as metals is one way hedge funds play the China boom, because China is one of the fastest growing users of commodities, according to Jim Melcher, founder of New York-based hedge fund firm Balestra Capital.

Manzke has long been attracted to Asia because its markets have continued to offer potential for high returns while at the same time becoming more sophisticated – for example, managers in Japan can now short stocks.

She recently launched an index product that is comprised of Asian funds. Manzke notes that China-based funds are on the rise – not just in Hong Kong, which boasts highly regulated and well-established markets, but on mainland China as well.

Manzke said there are currently eight hedge funds based in Shanghai, running a total of $406 million. She expects that market will grow as long as the Chinese stock market continues to outperform.

One of those Shanghai-based hedge funds is managed by Martin Currie, an Edinburgh, Scotland-based money management firm with $21.3 billion in assets.

Martin Currie's China hedge fund invests in greater China and focuses on small and mid-sized companies in which the management has a stake in the company, according to Allan MacLeod, head of sales for the firm.

MacLeod notes that the fund, which has holdings in Hong Kong and Taiwan, is up about 35 percent for the year to date.

Seven of the fund's 10 staff members are based in Shanghai, including Chris Ruffle, the lead portfolio manager for the firm's China funds, who is fluent in Mandarin. MacLeod said that conducting due diligence on an investment in China is different than conducting due diligence on more mature equity markets such as the U.S. and European markets.

"The markets are less well researched than other markets, so we have a very heavy emphasis on company visits," he said. "You need to know what to look for, and you need to know your way around Chinese accounting. Experience is extremely important."

Maxam Capital's Manzke said another important part of the due diligence process is getting to know which brokers, administrators and other entities that service hedge funds are reliable – especially important in light of the recent fraud at the U.S. hedge fund Bayou Group, which formed a fake entity to audit its own books.

"You have to do a lot more due diligence on the service providers," she said of investing in Asian hedge funds. "You want a recognizable, big name accounting firm, and when you are looking at funds in domiciles that are far away, they have different names, but when you dig down, you find that many are subsidiaries of Ernst & Young or some of the other big-name firms."

Indeed, corruption in China has kept some hedge fund managers away from the region.

"I have stayed away because corporate governance, stock market oversight and regulation are all pretty poor in China," said Balestra's Melcher. "One way to play it is through Hong Kong. You can operate there with some real confidence, and that's probably your most direct play. The other way is through Taiwan."

Manzke recommends investing in an Asia-focused index fund or fund of hedge funds, which would provide exposure to other markets in Asia in the event of a market downturn in China or certain sectors going out of favor.

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Chinese official sees quicker yuan moves: More here.

Hedge funds post best 1st quarter in 3 years: Click here.