Investors Walking Away from Private Equity Fund of Funds

With private equity fund raising at a critical crossroads in a difficult year,  a significant source of funding is beginning to lose its luster as investors steer away from private equity fund of funds due to their high fees. Long an integral source of capital in the alternative assets universe private equity fund of funds are losing favor with institutional investors who looking to more direct means of investing to avoid paying what they deem as excessive management fees. The management fees charged in fund of funds tend to run higher than direct funds because they not only include the fund manager’s fees, but also the management fees of all of the funds in the portfolio.

The recent announcement by Neuberger Berman Group that it raised $720 million for its NB Crossroads Fund, a fund of funds that invests in ventures, buyouts and secondary sales, is notable for its size, but also as it comes amidst a marked retrenchment of institutional investments in the general class of fund of funds. Industry analysts believe that such success will be much more difficult to achieve in the future as investors become more discerning about their alternative investment allocations.

Fund of funds had been considered an attractive alternative for risk wary investors looking for greater diversification and opportunities to participate in a wider range of alternative investments. But, as institutional investors develop greater abilities to conduct their own due diligence and exert their own influence in developing direct relationships with private equity fund managers, the rationale for working through a fund of funds manager diminishes. With the recent underwhelming performance of fund of funds, investors may no longer be able to justify the higher fees.

This decline of fund of funds comes at a difficult time for the private equity industry which has been suffering through a period of diminishing exit activity and lower investor commitments. Nearly 90% of exit activity has revolved around secondary sales and buyouts with the vast majority of private equity funds simply selling assets to one another. Losing a vital source of fresh capital closes yet another door on an industry beset with waning investor interest.

Tagged as: fund of funds, future of private equity, management fees, private equity industry