Small PE FoF / Co-Invest vs. Large PE FoF

chezparadise's picture
Rank: Chimp | banana points 6

Hi all,

Would appreciate people's thoughts on these two great opportunities that have offered me positions as Analyst / Sr Analyst

1) ~5Bn AUM PE FoF strategy, with 40-50% co-investments, with primarily FO and sovereign capital. Great small team of talented individuals (ivy undergrad and/or HBS); collegial environment that doesn't necessarily confine you to analyst job (will be meeting managers and speaking up early on).
2) FoF arm of large institutional investor, focusing on funds primary only as there's a separate team for direct / co-invest. Again, great team of larger size, although overall process seems to be a bit more bureaucratic due to sheer size. Definitely more well-known than 1) and Invests in regional / global mega funds mainly.

My background / goal: comp is not necessarily important at this stage of my career, I want to learn as much as possible about the FoF industry and would appreciate wide exposure and doing interesting work. Have the desire to go back to b-school in several years or so. Ultimately, I want to become a L.P.-type investor (instead of making Partner in a GP firm) as family has close to 100MM net worth to deploy

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Comments (5)

Dec 12, 2018

Why FoF? With 100 MM can't you go do deals yourself? Just curious.

"Truth is like poetry. And most people fucking hate poetry."

Dec 12, 2018

Diversification and lifestyle choices - it's much riskier to bet all available capital on 5-6 deals and we are not VC-type people at all (so can't do minority structuresd across multiple deals) The original source of wealth is not from finance so I don't think it's realistic to compete with GPs who have been doing this for decades. On a more general level, we are looking to deploy 100% in private equity class either.

Dec 13, 2018

I think you're making a huge mistake by looking to learn to allocate wealth via FoF. Look at how awful IRR is for investors net of fees...the whole thing is a joke.

You're also overestimating how smart GPs are. They are not very smart in my experience and I've met loads of people at name brand funds on the PE and VC side. Not rocket science to do what they do in most cases.

What you should do is work @ a LMM PE firm, and then start your own firm. $100M isn't quite enough to do your own fund with a robust team, so maybe start off with smaller deals following the independent sponsor model, and "test" potential hires that way, build a solid skill set, etc... then scale it into a fund once you're able to achieve real returns.

For your first IS deal, team up with solid management and ensure they co-invest, or work with another firm to minimize risk. Worst comes to worst and you're out $1M - $3M this way but you get to build a good skill set and don't do the truly dumb thing by earning subpar IRR for your family for an entire generation.

Also, there's a huge reason the whole FOF thing is dying and even pension funds are doing deals themselves...because FOF offers little to no value.

Finally, go join Tiger21 and YPO...you'll be running with a similar crowd facing the same issue. $100M is a small enough amount of money to where you can still relatively easily earn far more than 10% - 20% a year if you have above room temp IQ.

Andddd....

I'd encourage you think along the lines of generating alpha, not just raw IRR as almost nothing seems to beat a simple investment in the S&P500 if you go the passive/no skills route like the whole FOF thing.

Most Helpful
Dec 14, 2018

First, your stated goals:

Chezparadise:

I want to learn as much as possible about the FoF industry and would appreciate wide exposure and doing interesting work.

I would pick the first option. The contributing factors are:
- greater exposure
- co-investment experience
- lower bureaucracy or organizational politics and bloat

Exposure: You will learn more at a shop that has to deliver alpha through real manager selection than at a big, boring, sleepy old place that just chugs along because its scale and tenure has placed it in the tranche of the world where similarly calcified allocators just keep handing it money because of the narrow set of opportunities to park $500m commitments and safely get back an 8%+ net return.

The giant FoFs are by their size forced to stick with the big front-page GP names: there's a narrow universe of funds that can accept a $250m ticket.

The smaller shops don't have that issue of scale and can back:

  • emerging managers (usually someone who comes out of a prominent shop with a strong attributable track record, e.g. Searchlight [whose three founders were the co-head of media/comms at Apollo, a KKR partner, and the head of PE at OTPP] but is on Fund I or II)
  • managers whose strategy is scale-constrained (e.g. the guy who's figured out how to deliver 28% annually through a complex and unique fixed income strategy but can't tolerate more than $400m AUM)
  • managers in geographies some LPs shy away from (e.g. some guy in Singapore who is crushing it in illiquid or special situations credit in smaller APAC countries)

Compare this to a giant platform:

  • emerging managers are almost invariably a no-go; "no one gets fired for picking IBM" is the simplest way to say it - why go out on a limb for someone unproven when you can just fire a ticket into Carlyle VII (which hit its $18.5b hard cap, for the record) or if you're really feeling risky, into Fund II for one of KKR's new strategies (they launched a whole bunch of new real estate, growth equity, and credit businesses in the past five years)
  • managers whose strategy is scale-constrained are automatically a no-go because they can't accommodate your minimum check size; neither you nor they want you to be over 10% (tops 20%) of their capital base as an LP, so if your minimum check is $50m, they need to be a $500m fund for you to dance; some of these giant FoFs have a $100/$200m minimum ticket size ... you do the math
  • some geographies may be off limits due to political sensitivities; e.g. I know one big platform that has money from both CIC and CITIC; they did a ton of work on a manager in HK and ended up not being able to pull the trigger because the wife of one of the GPs was a prominent activist for the independence movement

Co-investment: This is important for two of your stated future goals.

  • (a) If you want to deploy your $100m family wealth, you're going to get way farther doing direct deals than you are allocating to external managers. For one, you can cherry-pick individual assets: you aren't committing to a blind pool that gets weighed down by the underperformers, you can sit back until something great comes along and go in solely on that. Secondly, you skip the fee layer. A lot of funds will let a family office co-invest on a fee-free basis simply because (i) the fund needs more equity powder to get the deal done and (ii) wants to develop a relationship so that party ends up becoming a fee-paying LP in future funds.
  • (b) If you want to go to b-school, you want the sexiest resume. Allocating to external managers doesn't get any adcom members fired up. Underwriting a few deals where you can bullet point exact dollar size, MoM, and IRR figures does.

Bureaucracy: I could write volumes on this. To keep it brief, you want to have a headache-free life. I can't stress strongly enough how shitty life can be inside a big place that has lots of different divisions, processes, and management layers.

You describe the first option as small, collegial, and flat. That probably won't end up being as true as you want it to be, but it sounds miles better than a place that's big enough to silo the primary fund commitment team away from the co-investment team ... both of which comprise one unit that's merely an 'arm' of a larger platform overall.

Second, the larger picture.

@m_1 pointed this out already. Generally speaking, you won't really move the needle tremendously investing in external managers. The exceptions are if you can get the majority of your capital allocated into best-in-class managers like Bridger, A16Z, Benchmark, H&F, etc., however the problem there is that those guys are oversubscribed several times over. You basically can't get in at all; what's the draw for the GP to accept some random family, especially when the best and shiniest sovereigns and institutional LPs are already in line asking to fire in nine-figure amounts.

What I think he missed is that you aren't trying to be an LP in a FoF, you're trying to recreate a FoF on your own by building a portfolio of primary fund commitments. He's right that LPs in FoF get a shitty deal. They are paying 1-and-5 to someone who bears a 2-and-20 structure from all the underlying GPs, so their LPs end up bearing a double fee layer and the returns get pretty diluted.

I disagree that $100m isn't enough to get started as a lower middle market buyout shop. It is. In today's financing environment that can be anywhere from $400-800m of purchasing power.

I recommend that you take the first position, flex your co-investment muscles as hard as you can, go to b-school, and find all the super sharp guys coming out of megafund private equity associate roles.

Back two of them as a search fund. Hell, do that with a couple pairs. Add yourself as a 'partner'. Maybe dilute your concentration as an LP by bringing in the FoF you worked at before school; if you did your job well, there's no reason they ought to be scared of committing <$10m to back a former employee's search fund (that said former employee is contributing family capital to himself).

Roll the clock forward 3-5 years and you'll probably have exited however many search fund deals you did. Hopefully you'll have (i) decent returns, thus improving your capital base, (ii) strong insight on the lower middle market deal space and process, and (iii) strong relationships with some talented investors from whom you can pick partners to help you run your own family office or lower middle market private equity shop.

At that point you have the choice of running solely principal capital or bringing in external capital. If you choose to go the latter route (be aware that that creates a series of headaches in their own right; you ought to be intimately acquainted with this thanks to your FoF role), your first call ought to be the FoF you worked at before school.

This ran long. I hope it's helpful.

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Dec 14, 2018
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