Alt assets sounds
Research firm advises taking care when investing in funds of funds, reports Roxane McMeeken.
Investing in private equity through funds of funds might not be the low risk, “no-brainer” it is frequently touted to be. An investment in a private equity fund of funds provides diversified exposure to an asset class that would otherwise be far more risky. Even if a fund of funds invests in vehicles that go belly-up, the rest of the portfolio should ensure that investors receive a decent return. With 120 firms managing private equity funds of funds worldwide, there is no shortage of opportunities for wealth managers to plunge into the market. However, it is worth taking a step back before doing so. New research suggests that the rapid growth of the market is unsustainable. Private equity research firm Alt Assets warns in a new report that the industry is well past its peak and is now on the cusp of a major consolidation. There is a real possibility that entire private equity funds of funds – not just their individual components – will start going bust. The private equity fund of funds sector manages around E130bn today, according to Alt Assets. However, the market was flooded in 2002, when more than half the market was seeking to raise new capital. The relative lack of success, particularly in Europe, highlighted the fact that consolidation is on the horizon, says Alt Assets. Moreover, very few fund of funds managers are doing anything original. “Most follow very similar regional and stage strategies by focusing on the US and Europe, and buy-out and venture,” says the report. Struggle to survive The conclusion is that 40 per cent of fund of funds players will struggle to survive over the medium term. Chris Davidson, head of research at Alt Assets, says that wealth managers should take extra care when investing in funds of funds from now on. “It used to be about offering diversified exposure – a good way of spreading risk. But the last few years have shown that private equity can produce a very wide diversity of returns, ranging from 50 per cent to zero per cent and less.” The result, he says, is that “investors need to go a bit further” in their assessments of fund of funds. “Be sensitive to the variety of products and their sophistication,” advises Mr Davidson. “The marketplace is still overcrowded and it’s not clear which people have what it takes for future success.” Past performance is not much of an indicator, he adds: “In the last few years the market has been extraordinary. This has led to confusion over who has the ability to achieve good performance and whose portfolio is irreparably damaged.” Mr Davidson says wealth managers should “look hard at the different products in the market – from large to small fund managers – and be aware of how they differ. You need to take a view of the market and decide which strategy you think will do best”. He advises selecting a private equity fund of funds that has sufficient scale to ensure a reasonable level of customer service, as well as a reputable team, which is committed to staying at the company. Finally, Mr Davidson says “be wary of opportunistic firms copying everyone else without a solid understanding of how they reached that conclusion.” In other words, avoid bandwagon players that entered the market when conditions were favourable, but now lack the strategies to handle the present tough environment.
