Why more FoFs will shift to secondaries

Secondaries can be an attractive growth area for funds of funds wanting to stay relevant, as limited partners move to reduce fees and invest in the private equity on their own.

This is one of the findings from the latest Adveq Applied Research Series conducted with the London Business School’s Coller Institute of Private Equity.

Historically, funds of funds have served as gate openers for LPs, providing access to popular general partners and oversubscribed funds, according to the report.

But in recent years, some LPs and GPs have changed the way they operate, which in turn is reducing the value of the traditional funds of funds for many investors.

Some of these changes include LPs becoming bigger and more sophisticated as well as LPs focusing on reducing the amount of fees they pay. On the GP side, some larger firms have developed in-house sales and support teams that make funds of funds less of a necessity for LPs.

Funds of funds are not becoming obsolete, but they do have to adapt to the new environment, the report said. It suggested that funds of funds can focus on mid-sized LPs and shift from relationships with larger GPs to smaller, more elite GPs, or concentrate more on the secondaries market.

Many funds of funds have already added a secondaries focus in addition to primaries. The report indicates that more of them will head in that direction in the next few years, but that route comes with its own set of challenges.

“The other area of growth for funds of funds is as a gateway for LPs looking to access co-investment or secondary funds or to establish their own separately managed account,” the report stated.

“However, funds of funds will need to gain the trust of LPs, which might be concerned by the conflict of interest created when a core fund of funds vehicle is used to generate deal flow for other funds.”

The authors of the report concludes that given the sophistication among funds of funds and LPs, they “expect that the sector will continue operating, with the hand-selection within this segment being more swift than in other part of the private equity ecosystem,” according to the report.

“Weaker fund of funds players will exit, whereas the stronger players with a good track record and solid links to LPs may continue growing and playing an important role in the sector.”