Private Equity Fund of Funds Managers and the Challenge of Attracting Investors

by Joe Childs

  • 17 Feb 2011
  • PE

A drop in the private equity market share of funds of funds in 2010 indicates that it was a particularly difficult year of fundraising for managers of these vehicles. The capital raised by funds of funds represented just 6% of the 2010 private equity market total, compared to an average of almost 11% over the previous five years. Preqin’s Q4 2010 survey of 148 fund of funds investors indicates that half intend to make new commitments to funds of funds in the next three years, while an additional quarter will consider making new commitments in this period. As evidenced by the prevailing fundraising market, however, investors are generally being more cautious than ever when making new commitments.

One-third of survey respondents that plan to commit to a private equity fund of funds in the next three years expect to do so in 2011, but 51% are yet to decide on the timing of any new activity. Firms that are seeking to raise new funds, therefore, will need to persuade investors of their attributes and to differentiate themselves in a market that offers plenty of alternatives. Given that the past performance of fund of funds managers has traditionally been a strong indicator of future performance, limited partners are also reviewing track records extensively, adding to the challenge faced by firms looking to secure capital.

Even for those fund of funds managers that do not have a new fund in the market, the indication is that they will need to carefully consider investor relations in order to secure re-up commitments in the future. Although investors commonly have long-established relationships with fund of funds managers, our survey also shows that just over half of respondents will remain open to investing with teams they have not made allocations to in the past.

There is a considerable gap between the best and worst fund of funds performers, and there is strong evidence that the top performing managers are successful across multiple funds. Analysis in this year’s Private Equity Fund of Funds Review (which presents fund-level performance data for over 600 fund of funds vehicles) shows that 39% of managers of top quartile funds of funds go on to manage a top quartile follow-on vehicle, while 66% of top quartile managers outperform the median benchmark with their next offering. This indicates that funds of funds continue to be a compelling investment solution for private equity investors if they can establish relationships with the right managers. However, conditions remain very challenging, and firms are having to work harder than ever in order to identify and attract new limited partners.

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