It is well known that smaller investors utilize fund of funds vehicles in order to gain exposure to various private equity fund types. According to Preqin’s Investor Intelligence online service, the typical investor in funds of funds has an average $22.5bn of assets under management (AUM), which is markedly less than the average AUM of non-fund of funds investors ($26.3bn). LPs interested in committing to funds of funds also allocate less to the private equity asset class than those who prefer single-manager private equity funds (an average of 8.1% and 11.1% of AUM respectively).
A key characteristic of private equity funds of funds is the double layer of fees, which impacts on returns. Despite this, Preqin’s database shows 2,185 active private equity investors that have previously invested in commingled funds or currently have a preference for such vehicles. It is likely that these LPs value the diversification inherent in funds of funds, as it reduces the level of risk in their investment portfolios.
Private equity fund of funds managers are also adapting to the new environment wherein the investor community is growing more mature and increasingly sophisticated; GPs are offering more flexible products and have become more willing to negotiate fees than in the past. For example, in 2014, Orange County Employees’ Retirement System (OCERS), a $12bn public pension fund, selected Pantheon to fulfil a fund of funds mandate. The pension fund will commit $50mn to $100mn annually for the next three years and expressed that Pantheon presented a product that allowed the investor to construct its own customized portfolio, as well as offering the best value.
The appetite for private equity funds of funds from institutional investors seems to persist; Preqin’s historical data demonstrates that the proportion of all tracked LPs with a preference for investing in funds of funds has hovered consistently around the 45% mark for the past three years. Moreover, Preqin’s Investor Intelligence database shows that 17% of mandates being sought over the next 12 months by investors are specifically for private equity funds of funds. Funds of funds carry lower risk, generate solid returns and offer access to fund types that may otherwise be out of reach for investors. As such, there is a compelling case to consider a fund of funds vehicle in an institutional investor’s portfolio.