A guide to Private Equity Fund of Funds

4 minutes
November 29, 2022

Over the past decade, Private Equity has increasingly become a significant part of most institutional portfolios worldwide. However, there are important considerations to be made in building a successful Private Equity portfolio, such as managing trust-based relationships with GPs, choosing investments that are sustainable and in line with the company's vision, and having a consistent strategy that takes into account possible market upheavals.

This is why investors very often choose Private Equity Funds rather than managing a portfolio of investments directly. Some investors may opt for further diversification by investing in a Fund of Funds (FoF). The FoF is in fact an investment fund that pools the capital of several investors to invest in a portfolio of Private Equity Funds.

Why is investing in a Private Equity Fund of Funds so attractive?

The main benefit of investing in a Private Equity FoF is that it provides investors with access to a diversified portfolio of Private Equity assets researched and chosen by a team of experts. 

Another benefit of investing in a Private Equity FoF is that it can provide investors with access to top-tier Private Equity fund managers who might otherwise be inaccessible. By pooling together capital from multiple investors and leveraging the GP’s relationships, FoF can gain access to leading Private Equity firms that manage large amounts of capital. 

What about the downsides?

As with any investment, there are some downsides associated with investing in Private Equity FoF. These risks include:

  1. High Fees: Besides the management fees and carried interest charged by a Private Equity Fund (traditionally 2% and 20%), a Private Equity Fund of Funds also charges management and carry fees.
  1. Limited Transparency:  Investors hire GPs to select and manage individual investments. With this comes less transparency and connection to individual investments. A FoF comes with two layers of GPs further reducing transparency.
  1. The commitment period: When selecting individual Private Equity investments, investors have the power to craft a timeline to their liking. With PE funds, this power is granted to the GP with a stated commitment period for the fund. With a FoF, the GP must account for the commitment periods of the individual PE funds as well. This may extend commitment periods, or complicate redemptions.

What to look for when choosing a Private Equity Fund of Funds

When choosing a Private Equity FoF, there are a few key things to look for: 

  1. Investment Strategy: Make sure that the fund’s investment strategy aligns with your own investment goals and objectives. GPs should be very transparent on their strategy.
  2. Fees: Be sure to understand the fees charged by the FoF and the funds being targeted. In some cases, these fees can be quite high.

  3. Performance: Make sure to review the fund and/or GP’s historical performance. While past performance is not necessarily indicative of future results, it can give you a view of how the team operates.

  4. Reputation: It is important to research the reputation of the GP. Be sure to read reviews and check references before investing. The GP’s ability to secure investments in overperforming Funds will be critical. 

Establishing a strong relationship between the General Partners and the investors

After an investment is placed with a FoF, maintain contact with the GP. Stay up to date on how the GP is selecting underlying Funds and how they gauge performance. Ask how reassessing and rebalancing occurs and why certain portfolio funds are over or underperforming. This may help guide future investment decisions.  

Key Takeaways

  • Investing in a Fund of Funds can provide you with diversification and access to top-tier Private Equity Funds.

  • Before investing in FoF you should consider a few key things like the investment strategy, the fees, the performance of previous years (if they are open-ended funds), and the reputation of the GP managing the portfolio.

  • Investors should not take a passive role once the investment has taken place, but instead should closely monitor the situation and actively propose follow-up meetings with the GPs.

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