Asian hedge funds – and the funds of funds that allocate to them – need to continuously evolve to suit the needs of institutional investors, says James Rice, head of the international group at US-based K2 Advisors.

“In Asia, we see an abundance of funds of $50 million and under. This is very hard for us, as a hedge fund of funds, if one of our clients wants to invest $5 million,” says Rice, who is based in the Hong Kong office of K2, which manages some $10 billion in assets.

“It seems that the sweet spot for Asian managers is $200 million to $300 million,” he adds. “That’s okay for us, because we can put a reasonable bulk of money into four to five managers.”

Investors in Europe and the US were keen to allocate to Asian hedge funds in 2011, he notes, despite a disparity in performance last year. Managers in the region were down by an average of -12.61% for the year, according to data provider Eurekahedge, although a handful pulled off double-digit gains.

“There is interest globally in having Asian exposure,” says Rice, citing the universal need for investors to diversify their portfolios. “Many of our Asian clients are looking for Western exposure.”

An institutional-quality infrastructure is a must-have feature for the funds in which K2 invests, he notes. While this has led to higher start-up costs for hedge funds in Asia, it is a key feature needed to attract institutional capital.

“It’s a fact of life,” says Rice. "You need to have an institutional platform." It is part of the evolution of the hedge fund industry, which is also affecting change at FoHFs.

Connecticut-based K2 was founded in 1994, initially serving high-net-worth investors. By the turn of the century, institutions had become its main clientele, including a notable number of pension funds.

In recent years, big institutions have started to move away from FoHFs in favour of running their hedge fund portfolios internally. The reason behind the trend was to save money on the fees charged by FoHFs, but Rice says the result is they need to pay staff to do the same job as a fund of funds.

To adapt to the changing environment, K2 has been building its advisory business for institutions, and also its platform for bespoke managed accounts and custom funds.

The firm runs several large managed accounts and custom funds, in addition to about a dozen FoHFs, says Rice, noting: “The accounts component of our product mix is growing.”

K2’s widened scope has helped raise its assets by more than 60% since the onset of the financial crisis in 2008, when it managed around $6 billion. In the intervening years, the company built up its presence in Asia-Pacific, where it now has some 16 staff across offices in Hong Kong, Sydney and Tokyo, along with a representative in Beijing.

K2 is planning for further expansion in the region in the coming years, says Rice, given Asia's demographics and rapid asset growth.