private equity funds of funds

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Private equity funds of funds

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The private equity asset class is a good way add more diversification into a portfolio.

An institutional or individual investor who wants to add diversification through private equity exposure in their portfolio would be able to get this exposure with either a direct investment into the individual private equity funds themselves, or into a private equity fund of funds.

There are several problems with investing directly into the individual private equity funds.

1) If the investor were to invest directly into the individual private equity funds, they would have to have to have a large capital base in order to get the proper diversification across the private equity asset class because the minimum investment into an individual private equity fund is very large.

2) Manger selection matters much more in private equity returns than in say, a publicly traded equity fund. The top returning private equity funds have the best managers. Many times it is not possible to invest in the top returning funds because the investor does not have any type of relationship with the best managers so the investor is basically locked out from the individual private equity fund.

3) The private equity universe is very large and the information is not as transparent as other investment fund areas. The cost of monitoring the private equity fund universe is an expensive comittment.

Private equity funds of funds provides the following solutions for the above problems:

Problem 1) is solved by the private equity fund of funds pooling investor money together and creating a larger capital base from which to invest from.

Problem 2) is solved by the private equity funds of funds focusing on relationship management with the individual private equity funds.

Problem 3) is solved by the private equity funds of funds specializing in monitoring performance of the individual private equity funds within the private equity universe. Many private equity funds of funds have large databases that hold information about individual private equity funds and their returns.

So if the added administrative costs of the private equity funds of funds is reasonable, than the private equity funds of funds approach is sensible when compared with the alternative of trying to invest into private equity funds directly.