Funds Of Funds: Buyer Beware

Now we at least have some company, thanks to a recent presentation by TorreyCove Capital Partners, a San Diego-based provider of private equity advisory work to institutional investors.

Buyouts has never argued that funds of funds don’t offer investors some advantages. For small investors without the deep pockets to construct a diversified portfolio on their own, the funds offer one of the few ways to play the private equity game. They can provide access to invitation-only funds. And they can offer a cost-effective way for investors to gain exposure to niche markets, such as Middle Eastern funds or first-time funds.

But they also have a big downside for investors: the additional layer of fees charged, on top of the plump fees paid to the underlying funds. There is also the difficulty, for highly diversified funds, of beating market benchmarks.

In March at the NASP Southern California Private Equity Conference, TorreyCove Capital went through statistics generated from a sample of some 567 funds of funds, vintages ranging from 2000 to 2009, compiled by data provider Preqin. Here are some of the takeaways:

• The median net IRR for the collection is 6.4 percent, and the median total value multiple is 1.21 times.
• Well more than half of the funds (59.8 percent) had yet to clear an 8 percent rate of return (in some cases using a total value multiple of 1.1 times as a proxy).
• Even first-quartile performance for the group of funds isn’t inspiring, at just 9.9 percent IRR and 1.35 times total value multiple.
• More than one in 10 funds of funds studied has to date lost money for investors.

In the presentation TorreyCove Capital went so far as to argue that “traditional fund-of-funds have outlived their time.” Among the reasons are the drop in private equity returns over time, making it even harder to justify the fees charged by funds-of-funds managers; the growing ability of investors to access top firms on their own; and the growing availability of “expert advice on portfolio construction.”

TorreyCove Capital Partners offers such advice, making the presentation appear somewhat self-serving. Still, while the firm does not manage funds of funds, TorreyCove Capital does provide advisory work to them. In addition, President and CEO David Fann wrote in an email to Buyouts, the firm believes “there are niches where the fund-of-funds approach makes sense such as frontier and emerging markets, small buyouts, and top tier (hard to access) venture firms.”