Market conditions for private equity are deteriorating, courtesy of the liquidity crunch. Funds of funds are adding more people to carry on growing their franchises.
Sounds paradoxical? It shouldn't. The going may be widely believed to be getting tougher, but professional private equity fund investors are showing no signs of preparing for a downturn. In fact, many appear to be planning for growth.
For example: according to market sources, leading funds of funds operators HarbourVest Partners and Pantheon Ventures are ramping up their headcounts by hiring up to 30 professionals each. Both firms declined to be specific about their recruitment objectives, but they did confirm that their businesses are poised for further growth, with an obvious impact on human resources.
“There are many arms to our business, and we continue to build strength and depth,” says Sally Collier, a partner at Pantheon in London.
There are several reasons why funds of funds may consider it an opportune time to bulk up now. Most obviously perhaps, there has been no evidence as of yet that the private equity investment business is experiencing a sharp drop in activity. The proprietors of the mega-buyout funds aside, who have lost their ability to finance large acquisitions as a result of the sub-prime and securitised credit debacle, most private equity and venture capital groups speak of business more or less as usual and cite cautious optimism when asked to grade their prospects for the next 12 to 24 months.
“New investments now benefit from a healthy correction as the shift we anticipated in the summer [of 2007] is actually taking place: leverage levels are falling, entry multiples are retreating, and average deal size has started to decline,” said global fund investor Partners Group in a note to clients in January about the environment for the buyout groups it invests in. The assessment implies a reduction in the overall total of equity capital being invested. What it doesn't anticipate is for the reduction to be crippling.
Even more encouraging for funds of funds strategists is that long-term investor support for the asset class remains strong. In October, Citi Investment Research interviewed 50 chief investment officers and pension fund managers in the US and Europe and found 75 percent planned to increase their target allocation to private equity in the next three years, from an average of 4 percent to 6.3 percent, potentially giving the asset class $400 billion in fresh capital commitments.
A study published by Coller Capital in December delivered an even more emphatic ‘thumbs up’ for private equity in the medium to long term: 96 percent of LPs polled by Coller were planning to increase their allocations, and 78 percent said they would grow the number of active GP relationships in their portfolio.
All this suggests that even if, as seems inevitable, there is a relative slowdown in the coming months, funds of funds acting as conduits of investor capital into private equity investment vehicles should expect to stay busy. Hence the need to carry on hiring qualified professionals.
In addition to the routine fundraising and manager selection work that funds of funds do, there are plenty of other things to keep them busy at the current time. Here is an overview of what any aspirational funds of funds manager is likely to be focused on today:
New territories. A new survey carried out by PEI, in association with the Institutional Limited Partner Association (ILPA), confirms that funds of funds clearly recognise the growth potential of the world's emerging private equity markets (see next story). More than half the 29 participating FoF groups said they will increase their allocations to Asia within three years, 45 percent predicted growth in Latin America, and 24 percent said the same about the Middle East and Africa. This isn't even remotely surprising: helping clients extend their reach into new geographies is arguably the most obvious way for a well-connected fund of funds to add value. To do this well, groups need people with locally applicable investment skills, which is one reason why many funds of funds are busily recruiting overseas.
Secondaries. In recent years, funds of funds groups such as Adams Street Partners, Capital Dynamics, HarbourVest, Goldman Sachs Asset Management, Pantheon and Partners Group have emerged among the most active participants in the secondary market. Says Pantheon's Collier: “Our secondary activity has been growing consistently, and we expect a further increase as a result of counter-cyclical investment activity in 2008 and 2009. With financial institutions likely to become net sellers, secondary volumes are bound to swell.” Which in turn requires the bandwidth to process increased secondary deal flow, and that requires more people.
We see huge growth in infrastructure funds, and we see a proliferation of infrastructure investment models. For private equity funds of funds managers, there are obvious ways to apply their skill sets to this rapidly growing market
Public markets. The novelty factor of listed private equity fund portfolios has worn off, with several such entities now trading. Listed funds provide their managers with access to new types of investors, but they are also labour-intensive in terms of administration and reporting. One of last year's most eye-catching new offerings in this segment was HarbourVest Global Private Equity (HVPE), an $830 million entity listed on the Euronext Stock Exchange in Amsterdam. George Anson, a managing director at HarbourVest in London, says: “Our current headcount at HarbourVest is 186. We average 10-15 percent headcount growth every year. With the creation of HVPE last year, I can see that continuing.”
New products. The growth of infrastructure as an asset class has not been lost on many private equity professionals, least of all the funds of funds. Partners Group already has a team in place, other groups including Pantheon and Unigestion in Geneva are rumoured to be on the brink of entering as well. Collier, without commenting on Pantheon's plans in this area, says: “We see huge growth in infrastructure funds, and we see a proliferation of infrastructure investment models. For private equity funds of funds managers, there are obvious ways to apply their skill sets to this rapidly growing market.”
In pursuing these and other strategic priorities, funds of funds are in the enviable position that even in the event of a severe slump, fee income streams are secure thanks to long-term lock-ups of their clients' capital. Firms that have raised large amounts of fresh capital during the fundraising boom of the past two years are now especially well-positioned to finance growth and recruit new staff. The fact that the world's best-known financial institutions, in particular the global investment banks, have started their cyclical downsizing rounds is a plus, too: it suggests more people with relevant experience are likely to be available.
Looking ahead, it seems safe to assume that the largest players in the fund of funds business will carry on getting larger still. At a time when nervous investors are seeking the comfort of perceived protected havens, the brand name groups are proving popular, especially in the established private equity markets of Europe and North America.
“There's little doubt that certain large, established funds of funds attract capital because LPs view them as safe,” says Sam Robinson, a director at London-based fund of funds SVG Capital. “Longevity counts a lot these days,” adds Terence Crikelair, a placement agent with Greenwich, Connecticut-based Champlain Advisors.
There may even be consolidation in the coming years, with large funds of funds swallowing the portfolios of some smaller, less popular rivals. M&A is a capital-intensive way of growing an investment team, and integrating large numbers of new colleagues is never easy. On the other hand, a well-struck deal can take care of a manager's recruitment needs in one fell swoop.