The performance of a sample of funds of funds ticked down this year during a tough time for the entire asset class. The track record of the sample, whose funds have collectively produced only a tiny profit for investors, continues to raise questions about whether funds of funds are worth the money.
Managers of funds of funds typically pool capital from wealthy investors and institutional investors, then over a period of time dole out commitments to venture capital, buyout and other private equity funds. The products come in a variety of flavors, from ones designed to provide investors a diversified portfolio with a single commitment to ones designed to provide exposure to a single strategy, such as distressed debt funds.
Managers commonly charge investors a 1 percent management fee, and many take a modest carried interest, such as 5 percent, after meeting a priority return. Many emphasize their ability to pick funds that perform among the top-tier of their peers, thanks to their expertise in due diligence, and access to invitation-only groups.
This year Buyouts compiled return data on 48 funds of funds to which six public pension funds committed $9.8 billion in capital from 1985 to 2003. The six are
So how did they do? Well, looking at just the 39 of the 48 funds that provided sufficient valuation data, the six investors have seen $5.4 billion in distributions on $8.3 billion in money drawn down. Including an estimate of the remaining value of holdings, investors have seen that $8.3 billion grow to $9.5 billion, for a 1.1x multiple. The median multiple of the 39 funds is also 1.1x. Twenty-seven of the funds list IRRs; the median IRR for those 27 is 9.1 percent. The multiples generated by the funds range from 0.47x on the low end to, on the high end, 3.37x.
Last year, in our analysis of a sample that wasn’t exactly comparable, 39 funds of funds that provided sufficient valuation data together generated a 1.2x multiple.
This year’s sample of 48 does include multiple examples of the same fund, since two or more investors often backed the same partnership. However, removing the duplicates so that each fund of funds appears just once in the sample doesn’t have much impact on the results. Doing so leaves a sample of 33 funds that provided sufficient valuation data for analysis; investors have seen $7.5 billion drawn down by those 33 funds grow into $8.4 billion, for a 1.1x multiple. The median multiple of the 33 funds is also 1.1x. The 17 that list IRRs generated a median IRR of 2.4 percent.
It’s tough to make an apples-to-apples comparison to the broader market. But this particular sample appears to be falling well short of generating median industry returns, let alone generating top-tier returns. According to the 2009 Investment Benchmarks Report, published by Thomson Reuters, the 708 U.S. buyout funds in the report’s sample formed from 1976 through 2008 have achieved a cumulative investment multiple of 1.4x for investors; the 1,269 U.S. venture funds in the sample formed from 1969 to 2008 have scored a cumulative investment multiple of 1.6x. The results would almost certainly be better if 2004 vintage and younger funds had been excluded, as we do with the funds-of-funds sample, since returns for younger funds tend to be depressed in the early years as management fees get drawn down (the j-curve effect).
Some caveats in evaluating our sample of funds of funds:
• It includes only a slice of the funds-of-funds universe and isn’t necessarily representative;
• The sample includes a smorgasbord of funds, many of which aren’t designed to back top-tier funds across the entire private equity market;
• Leaving out funds from vintages 2004 and younger still may not adequately remove the j-curve effect, since funds of funds tend to get drawn down over a period of years, as do the underlying funds;
• The underlying funds in our sample may be more tilted toward venture capital than the broader market, since many investors use funds of funds to access venture funds.