4.3 PE FoFs Flashcards
Fee structure of PE FoFs? Why still better to invest in FOFs?
Double layer of management and incentive fees.
For institutional investors still more cost efficient that in house
Otterlei and Barrington (2003) findings?
That an in-house team’s annual costs can be substantial compared to that of a typical FoF, and even a 5% carried interest charged by FoF managers has little adverse effect on PE investors’ net returns.
Successful PE funds require which 3 elements?
1) Broad network of contacts in order to gain access to high-quality funds
2) Well-trained investment judgment
3) Ability to assemble balanced portfolios
Probability of total loss of direct investment?
30%
How do FOFs provide reasonable downside protection?
Via greater diversification across GPs, vintage years, stages of investment, industries, and geographies
Benefits of FoFs for investors?
1) ACCESS: FoFs’ better access to top fund managers may also be because these managers consider FoF investors a more stable and experienced source of capital.
2) EXPERTISE: FoFs can also manage the challenging task of liquidity management that requires insight, an industry network, adequate resources, and access to research databases, as well as skills and experience in due diligence, negotiation, and contract structuring.
Differences of PE fund investment and FoF investment among 4 categories: diversification, cost, selection & monitoring skill and access
PE FoF key traits?
1) offer investors diversified access to PE
2) aim to add value by selecting top-quartile PE funds
3) may offer economies of scale
4) allocations to oversubscribed
PE funds.
PE FoFs differ in which 3 key dimensions?
1) Geographical focus
2) Focus (VC / growth equity / buyouts) or size
3) Portfolio Construction (diversification)
Diller and Herger (2009) findings?
Using two dimensions (i.e., number of fund commitments per year and number of vintage years) find that diversifying across 15 funds over 3-5 vintage years can reduce the loss of invested capital to zero and increase a PE fund portfolio’s average performance.
Dompé (2019) findings?
20-25 is the optimal size for a portfolio of PE funds diversified across stages, vintages, and geographies.
Once an optimal size is attained, adding more funds has negligible effect on risk reduction and may reduce the value added from manager selection.
2 broad categorizations of PE FoFs?
1) Primary FoFs - invest in individual funds at their inception, 20-50 funds, over several vintage years. Similar J curves to individual PE Funds
2) Secondary - acquire LP interest in secondary market. Hundreds of LP interests, know which investments the funds holds. Have shorter J curves than individual PE Funds
3 phases of PE FoF portfolio construction?
1) Portfolio construction (top down)
- number of PEs for adequate diversification
- spread across vintage years, geographies, PE Categories
2) GP and Fund selection (bottom up)
- qualitative & quantitative assessment of funds
- avoid investing if commitment amount is a large % of the total fund
3) Ongoing monitoring
- Regular interaction with the GP to know the status of the fund’s portfolio companies and the GP’s outlook on risks and opportunities.
- Regular performance analysis of the fund.
- Regular valuation of the fund.
(Some LPs sit on the fund’s LP advisory board to monitor potential conflicts of interest between the PE fund and the GP)
PE FoF investors rely on the FoF managers for what? Why should they evaluate them?
To perform portfolio construction
The investors should evaluate these managers to determine if they are able to select and access top quartile GPs.
Pros of PE FoFs investing?
1) Diversification benefit
2) Professional management - experienced investment teams, long-term horizon; targeted pool of capital; economies of scale
3) Access to funds, specific strategy, or geography
4) Lower capital commitment - single PE fund’s minimum investment is around $1 million