Talk to people in the funds of funds world and it won’t be long before the word “bifurcation” crops up. The sector is quickly polarising into two camps: those who can raise funds in this environment, and those who can’t.
Then again, you could apply that to the whole of the private equity industry. Fundraising is hard across the board for firms of all types at the moment, and has been for some time. The industry’s biggest traditional backers – US pension funds – remain enthusiastic about the asset class, but have become increasingly choosier and taking a harder line on fees when it comes to making traditional commitments. Regulatory changes aren’t helping GPs on the fundraising trail, either: capital requirements of Basel III and the likely strictures of the Volcker Rule have made it much more difficult for banks to invest in the asset class, while Solvency II has made it similarly tricky for insurance companies. Reduced targets and protracted roadshows have become the norm, with the time to get to a first close seemingly lengthening with each passing month.
But things are even worse for funds of funds, according to Alexander De Mol, a partner in Bain & Company’s Dubai office. To start with, he says, there is “increased pressure on fund terms” – and because funds of funds impose an extra layer of fees, they have been feeling the impact of this more than most.
Secondly, “Investors want more direct control and interaction with their fund investment … [they] increasingly look for transparency on their private asset ownership, for example for the purposes of monitoring risk”.
A further problem is that investors are waiting to see some cash back from their last round of investment before they pump any more money in.
So are funds of funds going out of fashion? In 2012, just $9.6 billion dollars were raised by funds of funds, according to figures compiled by Private Equity International. That’s well below the glory days of the first half of 2008, when this was about the run rate for a single quarter. And early signs suggest that there won’t be any massive rebound in the first quarter of 2013: at press time, funds of funds had raised about £100 million between them in the year to date. By way of comparison, buyout funds raised about $88 billion – nearly nine times as much. Performance has also been disappointing in recent years, according to most independent metrics.
Unsurprisingly, there has been some consolidation in the funds of funds world, as managers look to build scale and trim overheads. Last year BlackRock made headlines when it acquired Swiss Re’s funds of funds business to create the $15 billion BlackRock Private Equity Partners.
“In an environment where yields are low and volatility is high, clients around the world are embracing alternatives which offer higher return potential and the ability to mitigate risk,” Matthew Botein, managing director and head of BlackRock’s alternative investment group, said in a statement at the time. The deal instantly gave BlackRock a bigger footprint in Europe and Asia and extended its capabilities into infrastructure investing.
BlackRock hasn’t been the only one bolstering its geographic presence and product lines via acquisitions. Other recent deals include AlpInvest Partners’ absorption by The Carlyle Group, boosting the latter’s assets under management by some $45 billion. US group FLAG Capital Management also bought Hong Kong-based Squadron Capital (see box on p. 48), while Parish Capital was snapped up by StepStone Group (which is also now managing $4 billion in former Citi fund of funds assets as part of a secondary transaction). Previously, Hermes and Gartmore merged their funds of funds businesses, while Deutsche Bank merged its funds of funds with that of one of its acquisitions, the Sal. Oppenheim Group, and Russell Investments sold Pantheon to NYSE-listed asset management group Affiliated Managers Group. The list goes on.