Fund Of Funds: The Role It Plays

03 May, 2011

Let us face it – Asian private equity funds are becoming a lot more visible globally, compared to what they have been five or 10 years ago. Fund placement firms are becoming more efficient and many have set up offices in Hong Kong and Singapore, showcasing fund investment opportunities to investors worldwide. And there are a number of fund of funds (FOFs) which have set up shop in Asia since 2006-2007, leading to increased competition and overlapping of portfolios.

Hence, our role as a fund of funds in Asia is continually evolving. The ultimate goal for us is to be the ‘eyes and ears’ of our investors on the ground, provide value-added due diligence services and, of course, generate attractive returns.

However, as the private equity market becomes more transparent and the fund-of-funds landscape turns more competitive, we are increasingly finding the need to carve a niche for ourselves.

Investing in large, established private equity funds can no longer be our only strategy in Asia. (And believe me, many fund-of-funds investors will not want to pay fees for private equity funds which they can access and do the due diligence themselves, without our help).

Over the last few years, FOFs have adopted various strategies to define themselves in the market:

Co-investments: Lately, there have been several deals where LPs have co-invested alongside GPs. Through co-investments, LPs can selectively increase exposure to high quality companies, enhancing the potential upside of a fund-of-funds portfolio.

It also provides GPs the flexibility to do larger deals without sharing those with competitors. Furthermore, there may be opportunities for LPs to add value – either through sector knowledge or business introductions – depending on their backgrounds.

Secondaries: Acquiring existing LP interests (hopefully, with an attractive discount) through a secondary position allows one to evaluate the quality of the fund’s existing portfolio and the value of those assets. You kind of know what you are buying into and it’s no longer a blind pool. LPs today see secondaries as an important tool for changing the overall composition and liquidity profile of their portfolios.

Accessing smaller funds: In India, there are supposedly 300-400 private equity funds and in China, estimates are as high as 1000 (although how many are investible is questionable). Many of these are smaller, local funds.

Their mandate is to selectively invest in high growth small-sized and medium-sized businesses where they can add significant value to scale these companies to the next level. As one can imagine, this segment is highly fragmented and diverse, making it difficult for international investors to adequately access and diligence these opportunities.

Furthermore, there are global investors who cannot commit to funds below a certain size. Therefore, a fund of funds can allow an investor to penetrate this large universe of smaller local funds and build a portfolio of the best 20 in the region.

These are the three key areas of coverage and the modus operandi for any fund of funds in the region. The Asian fund-of-funds industry is likely to stay put, although its business models may change and require a continuous refinement of strategies.


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Fund Of Funds: The Role It Plays

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