Hedge funds have traditionally diversified themselves by strategy, but next up may be diversification based on geography, according to new research from Greenwich Associates.

The firm says in a new report that, “the hunt for ripe investment opportunities and institutional capital has led many hedge fund managers to leave behind their single-strategy roots and branch out into multi-strategy organizations. An increasing number of hedge funds are also realizing that uncovering lucrative new trades and appealing to capital-rich institutions might require another major step: geographic expansion.”

Greenwich reports that hedge funds in both North America and Europe are becoming more active in foreign markets. Many new hedge funds are hanging their shingles in Asia and other promising regions, it adds.

The firm says that European funds are leading the way in adopting a truly global approach to investing. The study reveals that, in addition to the 54% of European hedge funds that invest in the United States, half invest in Japan and almost 40% invest in the rest of Asia. A quarter of European hedge funds also make investments in Central/Eastern Europe, 16% invest in Latin America and another 15% invest in South Africa.

“The hedge funds that are moving most aggressively into foreign markets are primarily funds domiciled in London that are starting to look to non-U.S. markets and products for arbitrage opportunities in less efficient markets,” says Greenwich Associates consultant Jay Bennett.

North American funds are also moving abroad, although at a slower pace than their counterparts in Europe, Greenwich says. About 28% of U.S. hedge funds invest in Asia, including Japan. Approximately 17% invest in Central/Eastern Europe and slightly more than one in 10 invest in Latin America.

“European hedge funds are twice as likely as U.S. funds to invest in Asia — which is probably attributable to the simple fact that, from a time zone perspective, it’s much easier to do business in Asia from London than from New York,” says Greenwich Associates consultant John Colon.

Regardless of where they are located, large multi-strategy hedge funds are moving fastest into new markets, the firm observes. Of the more than 1,200 hedge funds participating in the survey, more than a third invest in Japan, slightly more than 30% invest in Asia excluding Japan, approximately 12% invest in Latin America, almost 20% invest in Central and Eastern Europe and 8% invest in South Africa.

“As hedge funds move into new regions like Asia, they are not limiting themselves to blue-chip investments or large, liquid markets,” it notes. “In particular, big multi-strategy funds are developing a considerable appetite for emerging markets — the fastest growing hedge fund investment strategy over the past 12 months.”

“The proportion of multi-strategy hedge funds with more than $1 billion in assets reporting that they are active in an emerging markets strategy increased from slightly more than 30% in 2005 to 37% in 2006,” says Greenwich Associates hedge fund specialist Karan Sampson.

The impact of these trends has been felt most keenly in Asia, Greenwich says, where proliferating hedge funds are accounting for a growing share of trading volumes in a variety of markets.

The findings are based on a survey of more than 1,200 hedge funds conducted by Greenwich Associates in conjunction with Global Custodian.