1 Adveq and the Coller Institute of Private Equity at the London Business School have teamed up to survey more than 1,200 public and private pension funds about the asset class. The survey revealed that public and private pension funds have increased their allocations to the asset class by hundreds of billions since 2005. Why did you launch the study and what has prompted this increased allocation?
We thought there was too little research out there on private equity and we wanted to add depth to the research space. The London Business School was leading the pack among the universities in Europe that were doing research on private equity topics, so we approached them to offer our help in financing their research and assist with establishing contacts at various pension funds. We’re planning to do two to four papers a year.
The private equity industry was hurt less than the public markets in 2008, which is one thing that makes private equity attractive. (But) the main driver, to me, lies in the interest rate environment; interest rates have been going down in the last few years and now they’re at zero, more or less. The search for yield has also helped drive interest in both public equities and private equity. For private equity, the good returns are a separate driver and have been exceeding public markets by several hundred basis points at a minimum for the last several years. Private equity also has an illiquidity premium, whereas pension funds have money they want to invest for a long time and don’t need liquidity immediately. So, it’s a natural marriage.
2 Moving into the role of Adveq as an LP – One thing we’ve seen on the fundraising front is a smaller number of hot funds get raised very quickly, but it’s a tougher process than it used to be for most others. Are you noticing this as well and are you able to get into the hottest funds?
Yes, I would agree. We’re getting into the types of private equity funds that reflect the focus of our investment strategy. We’ve always been very good at digging very deep and finding the best pockets of value for our investors. We allocate capital to a lot of relatively small buyout funds, one segment of the market that we think is the most attractive right now and where we
have longstanding relationships. When we go into a fund, we have a big role and look to share information that will help us share in our clients’ success. That creates opportunities for making co-investments in new transactions that our GPs originate and investing in secondaries that may also be coming to market.
3 LPs are also looking more closely at co-investing to save on fees. Is there an opportunity there for funds of funds?
We make co-investments with our GPs, but we don’t do it as a way to save on fees. It’s nice that you may have lower fees, but, to me, it’s about supporting our key GPs in their investment activities, especially within today’s highly competitive deal environment. In the lower end of the middle market where many of these firms need additional capital to round out their fundraising targets,
we’re seeing the most attractive returns and that’s what drives our investment activity rather than fees. We are an active investor in that segment of the deal market.
4 We’ve seen some consolidation in the fund-of-funds business with AlpInvest being bought. Do you see this trend continuing?
Yes, but it’s a more complex answer than you might think. Large buyout funds want to buy funds of funds to generate more information for themselves about the market, because funds of funds see nearly every deal that’s happening in the market — what’s going on, or likely to come. You’re seeing large buyout funds strengthen their ability to originate new deals outside of traditional investment bank auction processes by buying
a wave of consolidation occurring between funds of funds, because that would mean integrating new teams, eliminating redundancies and managing the other challenges that come with integrating another business. Institutional investors like insurance companies may buy a fund of funds because it’s cheaper to buy (one) than start one on your own. It’s also helpful to have an experienced team that thoroughly understands the business and can hit the ground running.
5 What kinds of opportunities do you see for funds of funds as private equity gains traction as an asset class?
You see 80 percent of smaller pension funds investing in funds of funds — that’s something that will remain. We’ll also see large investors that make $50 million to $100 million investments acquire stakes in 20 funds through a fund of funds instead of committing to one large fund. The economics are simply more attractive, net returns will be higher even after fees and they’ll get the diversification that they wouldn’t have otherwise. We also do secondary trades and a lot of co-investments in addition to investing in primaries. We’ve created a transactional part of our portfolio. It’s something that pays for additional fund-of-fund costs, and more.