Why is fund of funds a thing

Re: Citi private bank cutting ties with SkyBridge

Why is PE FoF a thing? Let's say you're looking to invest $500 million. If the FoF charges 1% then you're paying $5m to have someone go out there and look for funds to invest in. Is it worth the price tag? Wouldn't you just go and look for PE/HF that are performing well yourself?

 

if you’re a smaller investor you get diversification within alternatives that otherwise wouldn’t be available to you, as well as access to top managers that wouldn’t otherwise be available to you. joe schmo with $20 million can’t just knock on Blackstone’s door and take their pick of funds to invest in. FoF LPs tend to be smaller institutions and individuals vs. which is generally predominantly very large pensions/insurance cos/endowments, etc.

 

But it’s also less prestigious because of lower fees and lower value add

 

Speaking as a FoF investment professional, its true that FoF's double fee structure is a disadvantage and seems unfavorable to investors. But FoF still has value for alternative investors:

  1. large institutional investors like sovereign wealth fund and state pension has diversification requirements and they don't have enough in-house ability to do that, so FoF helps them achieve that.
  2. small investors don't have enough money for large GP like Blackstone or KKR, investing in FoF help you get into those large players.
  3. some GPs are niche and hard to get in or their allocation are scarce (because they tend to have a smaller fund to get higher return).
  4. There are some special LPs like corporations want to look for strategic acquisition opportunities so they invest in FoF as a deal sourcing channel.

According to Pitchbook data, FoF fundraising keep declining since 2014, which indicates an award situation.

 
Di-Jiang:
Speaking as a FoF investment professional, its true that FoF's double fee structure is a disadvantage and seems unfavorable to investors. But FoF still has value for alternative investors:
  1. large institutional investors like sovereign wealth fund and state pension has diversification requirements and they don't have enough in-house ability to do that, so FoF helps them achieve that.
  2. small investors don't have enough money for large GP like Blackstone or KKR, investing in FoF help you get into those large players.
  3. some GPs are niche and hard to get in or their allocation are scarce (because they tend to have a smaller fund to get higher return).
  4. There are some special LPs like corporations want to look for strategic acquisition opportunities so they invest in FoF as a deal sourcing channel.

According to Pitchbook data, FoF fundraising keep declining since 2014, which indicates an award situation.

Based on your experience, where do people go after FoF. Currently stuck in one and wondering where to exit to.

Do you find your work intellectually stimulating?

 
vanative:
what are thoughts on secondaries? feel like it’s a similar market

Secondaries has quite a bit different power dynamic as the GPs fund is already raised and there is quite a bit of value add secondary investors offer for LPs that aren't CPPB sized.
1. Some GPs have very restrictive transfer approval requirements for LPs often requiring Lps be subscribed to their funds. A secondary investor often has primary investments already in GP funds so has an advantage there. 2. There still is quite a bit of "hunting" for deals beyond the marketed processes. 3. For some of the mega secondary deals there can be quite a bit of diligence required (think 30 fund stakes with 10-15 companies each) and for fast moving deals a secondary investor may have the best view for valuation due to being already an LP for the funds in question. 4. Check sizes in the secondaries space can be much bigger limiting the universe of GPs.
5. Secondaries now consists of more than just buying and selling LP stakes with quite a bit of (I) GP led and secondary sponsor led continuation vehicles in addition to (ii) equity recap coinvestment opportunities for larger LPs for good asseta that alot of the larger secondary funds are actively pursuing.

 

As long as there are FoF primaries, secondaries ain't going to go away. Think of it as this; if there are 10 primaries transactions, that 10 transactions give rise to alot more (>10) permutations and combinations of secondaries transactions So yes, secondaries is a similar market because it is a subset of FoF market - but i'd argue that it is in a more robust space vis-a-vis primaries.

 
Biiscute:
As long as there are FoF primaries, secondaries ain't going to go away. Think of it as this; if there are 10 primaries transactions, that 10 transactions give rise to alot more (>10) permutations and combinations of secondaries transactions So yes, secondaries is a similar market because it is a subset of FoF market - but i'd argue that it is in a more robust space vis-a-vis primaries.

To be clear lp secondaries is not reliant on fof primaries.

FoF primaries isn't the main driver of the secondary market. The driver of the secondary market is large LPs (SWF, Pension funds, etc.) selling portfolios of LP stakes. These are directly held by the LP.

Yes there occasionally is FoF primary funds who need to sell stakes but those investors tend not to be the ones who need liquidity unless it's very tail-end.

 

Its pretty much a legacy business from back in the day when PE/HF were putting up heavy duty returns, but the people running big allocators didn't know what they were. They had pressure to allocate to the industry bc of the returns, but were uncomfortable as many of these funds can seem pretty whacky to someone who is used to running a 60/40 equity bond mix.

Enter some clever Anthony Scaramucci's with nice credentials who says "hey, I understand the asset class. Why don't you let me handle all the complicated stuff for you, and you get to tell your board you're doing cutting edge stuff".

 
arbjunkie:
Enter some clever Anthony Scaramucci's with nice credentials who says "hey, I understand the asset class. Why don't you let me handle all the complicated stuff for you, and you get to tell your board you're doing cutting edge stuff".

Don't forget the expensive suits - very important. FoFs were the investing industry's answer to "My kid tells me this Facebook thing is huge! What are we doing with Facebook?!?" c. 2010.

 

Alot of traditional private equity fund of funds activity is dying anyways.

Investment consultants like Stepstone group and Townsend have largely stepped in to help LPs evaluate new funds. You can find their recommendations online. They are a good "check the box" for LPs and also negotiate similar benefits to traditional fund of funds - ie; fee ratchets based on aggregate client size.

Also if say you are an LP who has say 100 - 200m to allocate to funds every couple years, it probably doesn't make sense to allocate to a megafund like Blackstone if you are looking for outsized returns. Megafunds are really useful when you need to write 500m checks, not when you are only making a few small stakes.

You likely are better off going to a few smaller funds and additionally be meaningfully big enough to get no fee co-investment access at that investment level.

 

Won’t recommend taking a job at this kind of place. Have friends working at a top 10 university endowment fund —which is a FoF and he told me every junior person wants to go to other places where they can directly work on investments, not obtaining knowledge about investment managers because its not very valuable skills. One of them quit after 6 month and it’s been a couple/few years interns don’t want return offers.

 

Everybody wants different things from their career. People who work at endowment funds learn how to appropriately deploy and allocate very very large sums of money. It's an important function that may not pay as much as a direct investing role, but the career/financial risks are highly mitigated by the diversification, the hours are also way better, and top endowment fund PMs make millions. For ex. Harvard endowment pays their associates (right out of banking programs), ~$200k per year (base + bonus) working 50 hours a week in Boston. Not bad?

 

I worked for an LP that normally was a normal LP in funds but used fund of funds to get Asia exposure. They didn't know the space and didn't want to get it wrong so they just outsourced it. One day when the team grows and/or the middle market asian PE space develops more they'll probably stop going into Asian fund of funds

 
m_1:
+1 FoF being outdated and pointless. Returns across PE funds running at scale are much lower than they used to be, which means more middle-men are being cut out.

A good way to see middle-men being cut out is by looking @ what some of the huge pension funds have been doing lately. OTPP is probably the best example of this.

Have to agere on this. Utterly pointless function. Doesn't develop transferable skill sets. Currently stuck in one and find it impossible to get out...

 

Lots of reasons.
1) size. LP is either too larger (big pension fund, SWF) or too small (family office) and so they need a FOF's help to get diversification and access. A large LP cannot generally deploy so much money themselves as it takes time to DD managers and monitor portfolios. Finding some good FoFs can really help. And if you're a family office you generally are not running a large enough team to do all the selection work so you hire FOF to do that for you.

2) diversification / access to new products / expertise: in Asia, where I live, several FOF had emerged because global LPs wanted access to Asia/China. It takes local expertise, langauge cpability, presence, etc to figure out who the good GP funds are and to manage the investments in them. I've seen the same for European VC for instance, or private credit. If you're an LP it's often better to hire the local specialist rather than do it yourself.

3) Access: some GPs are oversubscribed, and the only way in is through a FOF that's been investing with them for some time. This is less true now than in the past, since there's been a fair bit of disintermediation of FOFs. But for some highly-sought-after VCs for instance you need to still go through a legacy FOF (ie. Top Tier).

Broadly speaking though, FOF are less prevalent in the market than before. Many have shut down as intermeidation has happened, or some like Partners Group have transformed themselves into GPs with a small FOF arm, that is kept for strategic purposes - such as investing in GPs in order to get co-investment access.

 

what is typical comp and then comp progression like for a first year associate at a FoF after two years of banking? Is it similar to a PE but discounted a bit due to lower hours?

 

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