The ranks of private equity funds of funds are thinning, managers and other industry insiders say, with some predicting that close to half of them will disappear over the next several years.
“Many private equity funds of funds will disappear,” said Antoine Drean, founder and CEO at Triago, a Paris-based secondary private equity advisory firm and placement agent.
One reason for the decline, according to industry players, is that investors are shifting their private equity commitments to less traditional funds such as small and midmarket, distressed private equity and secondary markets private equity. Others are simply going direct.
Benoit Verbrugghe, senior managing director and head of the New York office for AXA Private Equity, also said that there could be fewer private equity firms in the future.
AXA Private Equity manages private equity funds of funds and invests directly in private equity deals as well as on the secondary market. Mr. Verbrugghe said firm executives estimate that of the 250 funds of funds currently in existence, up to 150 firms will be gone over the next few years.
“The old mainstream fund-of-funds model seems outdated,” Mr. Drean said. “As LPs become more sophisticated, the fund-of-fund option makes less sense, with its additional layer of fees and carried interest, and the danger of its overallocation model.”
Private equity firms overall are finding fundraising a tough slog right now.
In fact, of the $50.4 billion raised by private equity funds in the first quarter, including private equity real estate and infrastructure funds, only $2 billion was raised by private equity funds of funds, according to data from London-based alternative investment research firm Preqin. As of June 9, one other fund of funds closed with $700 million.
By comparison, in 2009, $7.2 billion was raised in seven funds of funds in the first quarter and $11.3 billion by 25 funds in the second quarter, according to Preqin.
“From our own perspective and I believe from the perspective of almost any fund of fund manager, we are having to work harder to attract investors,” said Beau Hurst, partner, Private Advisors LLC, a Richmond, Va.-based private equity fund-of-funds manager. “We are getting in front of more investors and traveling more. “
Fund-of-funds managers say most of their funds are losing investors because investors prefer direct investment in private equity funds and dislike the added layer of fees in a fund of funds as well as their lackluster performance.
While data on the performance of 2008 and 2009 vintage funds is not yet available, 2007 vintage private equity funds of funds have a median -10.3% internal rate of return, according to Preqin. Moreover, the median internal rate of return for these funds of funds has been below 1% since 2003.