The ability to grant access to “elite” private equity or venture capital funds has historically been one argument for the existence of funds of funds. And it could be a compelling argument for investors, who either couldn’t justify the ticket size for large funds or simply didn’t have the right connections.
Today, the promise of access does not impress.”Those who marketed themselves as granting access to the large, brand-name funds are the ones under the biggest pressure at the moment. What is the value of
What is the value of access, if you are accessing a very vulnerable segment of the market?
Industry insiders are split over how the global financial crisis – and the associated dent in private equity returns – will affect the fund of funds industry as a whole. There is a danger that the industry will suffer from a broader sense of dissatisfaction with the private equity asset class. Fund of funds, like their colleagues in the direct investment realm, may find themselves competing to manage a slice of a smaller quantum of capital.
The view from the front lines is, however, not universally downbeat. Tycho Sneyers, a partner at Swiss fund of funds manager LGT Capital Partners, feels that because some individual direct funds are experiencing extreme pressures, investors in the asset class will have a renewed appreciation of the diversification offered by funds of funds. “If you look at some of the direct portfolios established by large institutions, you see that some parties will have learned that they need exposure to a more diverse cross-section of funds,” he says. “People may learn from mistakes and funds of funds may benefit.”
Katharina Lichtner, managing director at Capital Dynamics, believes that fund of funds managers’ ability to assess changing GP teams will become increasingly important. As GP teams adjust to the economic environment, investment banking- and finance-driven deal makers are likely to make way for more operations-focused principals. “This brings with it an obvious compromise on team stability,” says Lichtner. “You have to be more flexible about team stability, because teams have to evolve to be successful going forward.” This adds to complexity of due diligence and the need to understand the individuals within a team, says Lichtner.
There is an increasing need for fund of funds managers to differentiate themselves from the competition. LGT’s Sneyers says that this may give rise to more specialist managers. “There will probably be more niche players, but they will find it difficult to compete with large operators offering niche products,” he says.
“Most allocations into funds of funds are from large pension funds that ideally want to work with large counterparties with global reach,” he continues, adding that to successfully assess GPs in certain niche sectors around the world, you would need locations in Asia, Europe and the US.
The ability to offer specialist, niche products may not be as important going forward as the ability to provide clients with institutional-style reporting functions. The new “dividing lines” between successful and unsuccessful managers will be drawn in the area of client servicing, says Bruno Raschle, founder of fund of funds firm Adveq.
“Services that are directed towards meeting the needs of chief investment officers and chief risk officers are now imperative,” says Raschle, adding that it is these two professionals who will be “asking the questions” for the next decade. “If private equity wants to remain as an asset class considered by CIOs or CROs, then we have to adapt the delivery of the product to meet their needs: needs which are akin to those in public equities.”
The need to institutionalise on a regulatory front, says David Currie, chief executive officer of SL Capital Partners, presents its own challenges as the industry heads into an era of more stringent regulation. “Some smaller players may struggle with the need for an additional overlay of compliance and regulatory structure,” he says. “It may mean more people and more technology.”
It could be argued that the threats and opportunities faced by the fund of funds sector have not been altered dramatically by the crisis. They have instead been brought into sharper focus. Fund of funds exist because the value of their selection and management should justify an added layer of fess. If those fees translate to 2 percent a year, then the fund must perform at least 2 percent better than an investor could achieve with its own fund selection. “This,” says Mair, “has always been the case”. ?
Niche work if you can get it
London-based Osmosis Capital was launched in 2008. The fledgling fund of funds manager is seeking to bridge the gap between institutional investors with an appetite for low-carbon investments and the wide array of managers in the sector. The firm is understood to be raising its first fund with a target size of around €200m. Jim Totty, partner and senior investment manager, spoke to PEI about the need for specialist funds of funds.
What is driving the need for specialist funds of funds?
“Primarily it is the increasing numbers of specialist GPs. In our database there are more than 330 low carbon GPs, ranging all the way from the earliest seed investor through venture capital and growth to infrastructure and buyout.
“On top of the standard due diligence you would carry out on any sort of GP, in this sector you need to carry out very specific diligence to ascertain whether the manager has a firm grasp of the issues such as regulatory risk or the political situation … and what these will look like in five years’ time. If capital is going to be exposed to technology risk, then you need to know that the investment team managing the capital have a firm grasp of the technologies they are investing in.
“Furthermore, in this niche of the market – as is probably the case in other niches – you do not have the benefit of extensive successful track records to analyse. In an area like buyouts you might have teams that have been together for five, 10 or 15 years. In the low carbon sector, you do not have that rear-view mirror; you just have to examine the road in front of you.”
How is LP appetite for niche funds?
“There are a lot of LPs who don’t have huge resources, but who understand and appreciate the long-term drivers behind the sector – energy security, price volatility, demand growth, etc – and who understand and like the private equity model. But then they look at the 300 funds out there; that is a lot of heavy lifting from a due diligence perspective. Furthermore, they see the need to diversify in what is a relatively new area.”