Fund of funds are an important component of many investors’ private equity portfolios; they are regarded as beneficial to those investors who would like to gain exposure to the asset class, but require the expertise of a fund of funds manager to help them access top managers as well as insight into the various strategies within private equity. Funds of funds can also provide investors with diversification benefits, as their strategy often encompasses exposure to a variety of strategies and geographies.
Horizon IRRs serve as a good tool for comparison of the returns of the main private equity fund types. Compared with buyout, mezzanine and distressed private equity funds, funds of funds have horizon IRRs that are lower over the one-, three- , five-and 10-year horizon, returning 7.9%, 11.1%, 5.3% and 8.2% respectively, as of June 2013. The relatively low returns of funds of funds, compared to traditional single-manager vehicles, can be partially attributed to the extra layer of management fees involved in investing in commingled funds. However, Preqin’s Performance Analyst online service shows that funds of funds perform better than venture capital funds in all the one-, three-, five- and 10-year horizons. While there have been several venture capital fund success stories with cases of even triple-figure IRRs, the strategy as a group suffers from significantly lower returns than the other private equity fund types.
Another method by which one can compare the returns of funds of funds to other strategies, as well as the public market is through the PrEQIn Index, which indexes returns rebased to 31 December 2000. Again, funds of funds display lower returns than buyout, distressed private equity, real estate and the all private equity index, but outperform venture capital, throughout the period. Since 2007, the PrEQIn Fund of Funds Index has also exceeded public market returns, in terms of the S&P 500 index, as well as displaying a far smoother trend line than both the public index and other private equity fund type indexes, particularly over the crisis period, illustrating the diversification benefits fund of funds can provide.