The private equity fund of funds business is hot. Funds of funds from newcomers to the approach are proliferating, while older partnerships are launching new offerings and searching for ways to remain competitive.
Here's a rundown:
* Massachusetts Institute of Technology, Boston, recently raised $167 million for its first fund of funds, geared strictly to foundations and endowments.
* Merrill Lynch Investment Management Co., New York, has hired former AT&T Investment Management Corp. private equity chief Russ Steenberg to manage its first fund of funds program for institutional investors. The program will include retail investors and is targeted at $500 million.
* Pilgrim Baxter & Associates Ltd., Wayne, Pa., is raising its first fund of funds. Carol Proffer was hired in June 1999 to oversee the effort, which is geared to midsized pension funds.
* Botanica Capital Partners LLC, New York, is in the early stages of being launched by Rosalie Wolf, former treasurer of the Rockefeller Foundation, with partners that have yet to be identified. It will aim to reach $200 million to $350 million and seek founding investors with the ability to commit large amounts of capital.
* Commonfund Capital Inc., Wilton, Conn., which traditionally managed funds of funds strictly for educational institutions has broadened to offer its products to foundations as well.
* The Investment Fund for Foundations, Charlottesville, Va., which previously invested solely for foundations, has responded by targeting educational institutions, too.
Some industry watchers believe the fund-of-funds market is reaching saturation. Others, however, said that while it isn't there yet, the activity level leaves room for marginal players to jump in, which could ultimately raise the riskiness of the asset class.
Although the funds attempt to offer different strategies, there is duplication, said Sanji Mansukhani, associate director of research, alternative assets, at consultant Evaluation Associates, Norwalk, Conn. "There are just so many strategies managers can use. It makes my job tougher to try to find the differences between the newer funds coming in and the older ones," he said.
But there still are a lot of fund of funds searches, especially among endowments, said Gary Robertson, vice president at consultant Callan Associates Inc., San Francisco. "The larger ones (endowments) do their own thing, but many of the smaller ones want to be in funds of funds to get access and diversification quickly."
A shot at higher profits is behind the increase in funds of funds, said Mr. Robertson.
"There is a push for managers to look at them, because they can charge fees based on commitments rather than on net asset value, raising the margins considerably," he said.
In addition, investment banks and brokerages with major presences in managing public securities have discovered private equity is such a big business they need funds of funds if they want to be full-service firms, said Kevin Albert, managing director at Merrill Lynch Investment Management, New York.
While Merrill Lynch, like most large brokerages, began offering funds of funds to individual investors four years ago, it just launched a program that will invest globally and be available both to institutions and high-net-worth individuals. The targeted amount for the combined funds is $500 million. Merrill will invest 70% in the United States and 30% internationally; 70% of its investments will be in partnerships, 30% will be direct.
Mr. Steenberg, the managing director who is running the new fund of funds, has relationships with top-tier partnerships that date back 15 years, from his days as managing director of the private equity program at ATTIMCO, which should give him access to the best partnerships, Mr. Albert said.
MIT mix
One of the new developments, MIT's plan to let the managers that invest for its private equity program invest for outside clients for the first time, will create a lot of conflicts, several experts said.
"If a company in the in-house fund and another in the external fund are holding meetings on the same day, how will they decide which one to attend?" asked an industry executive who did not want to be identified. "It's going to be a distraction for the staff's time. Are they working for the university or outsiders?"
He and others also criticized MIT's plan to invest in new partnerships for the external clients rather than the blue-chip hard-to-access funds such as Kleiner Perkins Caufield & Byers and Greylock Management Corp., which have contributed to the huge success of MIT's internal private equity program.
"It's not clear that they were offering anything more than I could get from the Commonfund," said the director of investments at an endowment that invests through the Commonfund and who studied MIT's offering. "I didn't see any advantage to going into it."
Officials at MIT declined to discuss the new fund.
Industry observers speculated that MIT launched the fund as a way to retain the talented portfolio managers running its private equity investments. The new fund would allow MIT to offer them higher salaries that would include a minimum 20% of the profits on top of the compensation package. But as one competitor noted, "They could just give them a raise without starting a separate fund."
MIT's foray into a fund just for foundations and endowments has sparked new competition in that market. In May, both the Commonfund and The Investment Fund for Foundations, or TIFF, broadened their client bases.
John Griswold, managing director at Commonfund, said that a number of foundations, hospitals and other charities had asked for an opportunity to invest with Commonfund.
Commonfund revisions
The Commonfund, which manages $26 billion in assets for endowments, has revised its charter and in the fall expects to offer several investment vehicles for foundations, that will include private equity funds of funds as well as public market funds. Mr. Griswold could not detail them, because they are about to go into registration. "There is little out there that is cost efficient for many of these charities to invest in, and we're just responding to a need," he said, adding there is plenty of business for both the Commonfund and TIFF.
Consultants noted that both organizations have reasonable fee structures for funds of funds, compared with commercial operations that often double management fees and carry charges.
The Commonfund charges around 45 basis points, according to sources. TIFF last year charged 63 basis points on committed capital in its private equity program, after returning 15% of fees that had been paid because the program generated a big surplus. Fees drop substantially after a fund reaches its fourth year, said David Salem, president and chief executive officer.
In a recent speech at a TIFF forum, Mr. Salem, explained the change of heart about investing for educational endowments. "It makes very little sense for TIFF to manage money for foundations in an effort to enhance the vitality of the non-profit sector, but to say to these same members that the instant they shift money into the hands of a grantee that happens to be a school this money is no longer eligible for the vehicles that TIFF administers.
"Moreover, in light of Commonfund's recent decision to broaden hugely its own eligibility criteria so that it can pursue aggressively meaningful shares of the foundation market, the hospital market, the non-profit market in Canada and other avowed aims, it is illogical for TIFF to continue to say that TIFF is open to all charities not eligible for Commonfund."
A few small educational endowments he would not identify already have signed up with TIFF, which has not yet talked to larger universities. "We're very comfortable with our asset base," Mr. Salem said, noting that its assets and funds are on a much smaller scale than the Commonfund.
As of June 30, TIFF managed $1.67 billion in total assets, based on capital commitments, with $366 million of that committed among three private equity funds of funds. The most recent, TIFF Partners III, had $164 million in committed capital.
