'US$20 billion to US$50 billion is a conservative estimate. Our regulators should pay more attention to hedge funds,' said Chinese Academy of Social Sciences researcher Zhang Yuewen, who conducted the study.

That estimate is equivalent to more than a third of the about one trillion yuan in assets managed by mutual funds on the mainland.

'China should enhance supervision of short-term capital flows and appropriately restrict business between domestic financial institutions and hedge funds,' Mr Zhang said. 'We don't know much about hedge funds, so regulators should ask commercial banks to reduce direct lending to them.

He noted that the funds tended to be short-term investors and could unsettle markets.

During an internal academy lecture in Beijing yesterday, Mr Zhang said overseas hedge fund money might be flowing into the mainland through the QFII scheme - the only authorised access foreign investors have to A shares - by acquiring quotas from large institutional investors.

Money could also be entering through local companies controlled by the funds, co-operative efforts with domestic private placement firms or through illegal banks, he said.

'There are certainly plenty of ways to bring illegal funds into China. This is an enormous grey area and there are organisations willing to help funds do this,' said Peter Alexander, a principal of Shanghai-based investment consultant Z-Ben Advisors.

According to a source, private equity and hedge funds have been avoiding mainland capital controls to invest in stocks, using global banks to funnel money into the country.

The source said a fund could deposit money into an offshore bank account on the unwritten understanding that it could borrow a similar amount in yuan from the same lender's mainland operations.

China launched the QFII programme at the end of 2002 and has so far approved quotas for 52 overseas institutions.

The China Business News yesterday quoted an unnamed source as saying Beijing might triple the QFII quota to US$30 billion during this week's Sino-US strategic economic dialogue in Washington.

'The quota shouldn't be increased at one time, but raised over the long term, say five years,' said Julia Zhao, who oversees QFII business for Guotai Junan Securities in Shanghai.

Mr Zhang cited London-based HedgeFund Intelligence as saying hedge funds had US$128 billion in assets in Asia in June last year, including US$48.5 billion invested in the Japanese markets and US$20 billion in Hong Kong.

Most of the remainder had poured into the mainland, he said.

The mainland's foreign exchange reserves increased by US$135.7 billion in the first quarter, US$73.4 billion more than the combined value of foreign direct investment and the trade surplus for the January-March period. The major discrepancy has prompted speculation among analysts about hot money flowing into the country.

Earlier this week, the State Administration of Foreign Exchange said unusual capital inflows had been detected in trade and capital accounts in 10 coastal provinces and municipalities, the Shanghai Securities News reported.

Hedge funds were widely blamed for accelerating the 1997 Asian financial crisis, but their demand for financing and brokerage services have made them lucrative clients for investment banks.

Additional reporting by Cameron Dueck and Chaim Estulin