Less money has been committed to private equity funds year-on-year since 2000. A myriad number of articles have documented the problems of over-allocation, the lack of distributions and changes in regulations reducing banks and insurance companies’ affinity for the asset class.
Fundraising for all types of private equity is tougher than it was. Pensions, banks, insurance companies and corporates have become a less significant source of capital.
Conversely the role of fund of funds and gatekeepers has increased greatly. In turn, this group has driven a change in the way diligence on funds is being conducted as well as the value that intermediaries like placement agents can bring to the fundraising process.
The European market is particularly rich pickings for the fund of funds industry due to the existence of a large number of small investors who need to invest in a fund of funds in order to have access to a diversified private equity portfolio.
The crowded market has spawned an evolution in the different industry models. Funds of funds tend to differentiate themselves by their primary/secondary split, their sector and geographic focus and the size of their commitments. This differentiation has been driven largely by the following factors:
· the increasing sophistication of investors going into funds of funds;
· increasingly proactive pension consultants;
· new entrants’ need to differentiate themselves from incumbent FoF managers;
· the incumbents offering different product lines as well.
The number of financial institutions using gatekeepers has also increased. Institutions who establish a relationship with a gatekeeper generally do so because the amount they aim to invest in the asset class means that it is the most economical option (as opposed to investing in a fund of fund or establishing their own team) and also because they aim to maintain the final investment decision themselves. Generally, the relationship between gatekeepers and their clients tends to be close, which means that the majority of gatekeepers are in close proximity to them.
What does this mean for the GPs who are fundraising? It definitely means increased diligence, meetings with prospective investors when they are not fundraising, a polarised market between those that whistle through and those that struggle.
It is also true that a knowledge of the differing products that fund of funds are offering is necessary in order to understand who is most likely to invest and consequently where a GP’s time is best spent.
But what are the underlying dynamics of dealing with gatekeepers or a fund of fund? Clearly this depends on the individual organisations and personalities involved. However, both often have a multi-stage due diligence process, meaning that they form conclusions at certain points in the diligence process over whether to proceed to the next stage. In the case of a gatekeeper, these decisions would be based on a client’s willingness in paying for more due diligence to be completed.
The sophistication of funds of funds and gatekeepers has made the fundraising process much more complex, explaining the increased use of placement agents and the increasing number of GPs with dedicated investor relations resource. For GPs to be successful at raising money in this environment, they have to have a track record, but they also need to understand how their business looks to investors, how they fit within the overall GP landscape and market themselves accordingly. It is difficult to see this trend being reversed in the future.
James Coleman is a director in Deloitte's Fund Placement Advisory Group in London.