China can feel like a black hole,” says Violet Ho, managing director at the investigative firm Kroll in Beijing. Foreigners investing there often know little about the country. There are language and cultural barriers. Ho says due diligence on fund managers in China typically takes about four weeks. That’s twice as long as in the US or Europe.

China is not unique in Asia. The region’s alternative investment industry is relatively new and undeveloped. It’s rare for firms to raise their second or third fund and or make divestments yet. More often, you see traders striking out on their own as hedge fund managers, or bankers seeking money for their debut in private equity.

Nevertheless, investors are coming back to Asia. Ho says the demand for Kroll’s due diligence services rose throughout 2010, after dipping in the first quarter.

Funds of funds want to examine potential alternative investments, and outside investors want to investigate the general partners who run private equity funds.

“GPs have so much more leeway in Asia,” she says.

Very little investigation is online. Instead, it takes a lot of old-fashioned footwork and talking with contacts to check up on investments and managers. Typical due diligence on a fund manager could involve talking to individuals who have worked him the manager or parties on the other side of transactions to get some perspectives.

In addition to background checks on managers, hedge fund investors go over strategy. Allen Sing of Hong Kong-based Sail Investors, which invests in hedge funds, emphasises the importance of separating skill from luck.

“Relying on a good track record is insufficient,” Sing says. “[Managers] must be able to answer whether the performance is repeatable and why.

“It’s important to understand how managers arrive at a decision, their thought processes and why they bought or sold when they did. If one follows a manager long enough, one can see whether their actions are consistent with their described strategy,” Sing says.

It is also important to understand a fund manager’s social network of friends, associates and former colleagues.

If one fund is investigated for insider trading, for example, who else is working in the same or similar networks? At the least this should raise some natural questions to look further into, Sing says.

Private equity investors also need to spend a fair amount of their own time on quantitative analysis, They should evaluate profitability through measures such as EBITDA, operating performance, growth, and the many other factors that determine the value of existing investments that have yet to be divested. That’s particularly important in Asia where many private equity funds have shorter track records and have divested fewer investments.

And as we have seen in the most high-profile of hedge fund failures, it’s also vital to look into a firm’s operations. “The majority of hedge funds fail not because of performance but because of operational reasons,” says Rory Kennedy, chief operating officer at Rogers Investment Advisors in Tokyo. “Most hedge fund managers are not good back-office managers.”

Despite the uptick in interest, fundraising remains difficult for smaller funds. Hedge Fund Research found that investors allocated a net $19 billion of new capital to the hedge-fund industry globally in the third quarter of 2010—the largest inflow since late 2007. But much of this is going to larger, established funds. Investors also tend to favour firms that are based in the west.

“There’s still a fear of handing capital over to managers who are ‘native Asian’—that is, Asia-dedicated funds that are based in the region,” says James Chirnside of Asia Pacific in Sydney. Many managers prefer to hand their capital to folks they know already, he says

The fund-of-funds industry should have benefited from the boom in interest in Asia. But it is still sluggish, as it continues to deal with the aftermath of poor performance in 2008.

The Centre for Asia Private Equity Research says Asian funds of private equity funds raised $1.9 billion between January and November, a drop of 21% compared to the same period a year ago.

It’s a similar story for funds of hedge funds. Capital is starting to trickle back into the industry for the first time since the Madoff affair, according to Singapore-based hedge fund data provider Eurekahedge.

Poorly performing of funds of funds in 2008 “led many to think they can do it themselves, and of course they can. But their abilities have not been tested in times of crisis,” says Kennedy at Rogers.

“There are very few pension funds that are capable of doing due diligence on hedge funds. They don’t have the team or resources.”

Kennedy says some managers use consultants, instead of trying to do it themselves. The trouble with this approach is that consultants have no fiduciary duty. Managers can also hire experts to work in-house, but experienced managers—with direct experience investing in hedge funds or private equity funds in Asia—are not easy to find.

Kennedy and others see flows back into funds of funds starting this year. There are some practical reasons for this. “Most in the west know they need to be in Asia, but how on earth can they do it themselves? Funds in Asia are too far and too small,” Kennedy says. Due diligence in Asia takes more time and resources, and that will eat into returns. Ho at Kroll adds: “It doesn’t make sense for investors to spend the value of their investment on due diligence.”