Mega funds like Ontario Teachers have been in the press about side stepping private equity funds and investing directly into companies, taking on the responsibility of board governance to ensure performance. This is a nice thought, but really, the private equity funds, in general, do a very difficult job very well, and I find it hard to see their skills being done by the larger funds. The big fund's time is better suited doing the bigger picture and leaving the PE funds to do the dirty work.
David Currie at SL Capital has just put out an article explaining the reasoning of this. David says:
"The majority of global pension funds remain open to the idea that the additional layer of fees charged by private equity fund of funds represents a price worth paying to get the requisite access and the assurance over administration and compliance that an experienced manager can bring. Our pension fund clients engage us to provide a complete private equity solution for what is typically only ever up to 5 per cent of their total investment portfolio."
The majority of pension funds do not have the €100m (£83m, $132m) allocation to private equity that has been noted as the level that would allow them to invest directly in a structured long-term way into private equity. For these schemes, the hurdles of minimum allocation, administration of the investments and the risk diversification mean that a fund of funds is the only viable route.
In SL Capital’s fund of funds, the average commitment by a client is €12m, which would normally represent the pension fund’s entire private equity commitment, or at least its entire US or European private equity commitment. It is impossible to get true diversification, across at least 10 private equity funds, with a €12m allocation, as most funds require a minimum commitment of €5m.
It is also worth noting that the larger funds of funds sit on the private equity funds’ advisory boards as a matter of course. These positions are open only to the largest or most sophisticated investors and offer a deeper access and relationship to the manager, enabling added insight, a view on strategic direction and a first look at valuations and performance. This really matters when times are difficult, as the experienced fund of funds investors can deploy their team’s deep knowledge and expertise to help restore confidence in leadership or offer solutions to ensure all investors are protected.
While the world’s largest pension funds operate significant teams globally, we as a fund of funds also work closely with them to deploy capital. In this case we are providing support in a specific area of the European or US markets that they find hard to access, due to their proximity to the market or knowledge of the best managers in that segment. In these terms we are the “eyes and ears” for these larger groups in specific areas, such as smaller, regional or local funds, secondaries and direct co-investments. They recognise the advantages of working with fund of funds that can add value to their overall programme.
