These days, it’s tough to raise capital as a boutique, specialised fund of funds.
As limited partners increasingly trim the number of their GP/FOF relationships, they are generally choosing the larger, more diversified fund of funds managers that can give them broad exposure to various strategies, including emerging and developed markets, comments Nicholas Morriss, co-founder of fund of funds manager EMAlternatives.
The era of specialised shopping may be over for now. Funds of funds today need to offer a broader suite of products, and also need to be large enough to absorb cuts in fees they may have to agree with their investors, who themselves are increasingly under pressure to squeeze managers to cut costs.
Before the market downturn in 2008, smaller funds of funds had the opportunity to get institutional investors into scarce or specialised allocations.
In today’s environment, the larger fund of funds managers have moved into the specialised spaces once inhabited by boutique firms, putting competitive pressure on the strategies, and crowding out smaller players, resulting in a consolidation of FOF managers. As institutional investors work to make their portfolios more manageable, with fewer managers and funds to monitor, they are tending to favour the bigger players that can serve multiple needs, rather than numerous smaller funds, according to Morriss.
There is also the natural development of an institution’s experience investing in a specialised field like emerging markets. Institutions gain greater knowledge of the specific strategy over time as they’ve worked with their managers; they have less need of specialised managers to identify or direct them to the best funds. Specifically for emerging markets, in recent years, they have developed much greater institutional familiarity and awareness of the space. This education will only continue, says Morriss, even as the universe of GPs in emerging markets continues to increase in size and complexity.
These various factors are combining to make life tougher for smaller, specialised fund of funds managers. Even for primary fund managers, raising capital has become harder, save perhaps for those managers that had raised several funds in the past and have proven track records. With limited liquidity, institutional investors today are more focused on re-upping with trusted managers rather than developing new relationships.
That’s not to say that there isn’t a bright future for funds of funds in general, but they will need to be of a larger variety to adapt to the changing appetites of LPs, Morriss says.