News analysis: The FoF phenomenon

PEI Asia editor Jenny Blinch examines whether there are too many fund of funds operating in Asia.

Five years ago, only a handful of funds of funds had a base in Asia. Today, estimates put the number of such funds here between 40 and 66, depending on where the boundaries around the region are drawn and which strategies are included.

Besides just keeping pace with the overall growth of the Asian private equity industry since 2005, the (ongoing) growth of the fund of fund industry here has been fed by accelerating interest in Asia from investors outside the region, which – in many cases – has not been matched by an increase in Asia expertise.

In fact, funds of funds have been instrumental in building the profile – and AuM – of Asian private equity, acting as a bridge between West and East, with knowledge flowing one way, and capital the other. This, still valid, role is reflected in the relatively higher proportion of commitments GPs in Asia typically have from the fund of funds community compared to other markets – one Asian LP says GPs in Asia glean on average around 50 percent of their investments from the fund of fund industry.

Putting this heritage aside, however, there are now many in the region who are saying that the proliferation of funds of funds has outstripped the pace of development of the industry. Demand, they say, now exceeds supply on the fund side.

“Lots of capital is coming into Asia, but fund formation is not keeping up with it,” commented one Hong Kong-based fund of fund manager recently.

This shortage of investable funds has been exacerbated by the so-called flight to quality, which has, in effect, been a flight to brand names, he added.

Questions are also being asked about the value-add of fund of funds in Asia, given the relatively small universe of proven managers in each country targeted by many of the players. There is no way to compare the portfolios of each fund of fund manager, but sceptics say the level of overlap in terms of managers might be as high as 60 – or even 80 – percent in the mainstream of the Asian fund of funds industry.

With the above in mind, an increasing number of people are predicting that a shake-out of the Asian fund of funds industry is inevitable and necessary. However, it is not likely to come any time soon.

“Although technically this should be a sector ripe for consolidation, it’s very hard to do,” acknowledged another Hong Kong-based fund of funds manager. He noted that once a firm had raised a first fund, it was effectively in business for 10 years.

Nonetheless, some downsizing of the industry will come. Fund of funds clearly still have a vital role to play in Asian private equity, but there are too many of them trying to play it right now.