What is a Private Equity Fund of Funds?
If you’ve read through some of the articles in the private equity section, you should now know that private equity funds are both an attractive investment, and the backbone of the economy. Though these ARE key points to understand, remember, they’re just basic fundamentals, allowing you to understand the more complex aspects of private equity investing.
In this article, we will cover a more advanced topic that has become rather common in the private equity industry. By supplying it’s definition, applications, benefits, and more, you will learn everything you need to know about the new trend, the Private Equity Fund of Funds.
The “fund of funds” strategy has become popular in recent years for one reason: it can DRAMATICALLY reduce volatility for fund managers and their investors. You may say, “How can a fund of funds investment produce a more stable yield for investors?” Well, since this is a great question, we will take a few minutes to answer it in detail.
By definition, a “private equity fund of funds” is an investment structure that pools capital from investors and allocates it other private equity funds, instead of investing directly with those requesting the capital. Once a “fund of funds” has invested with several smaller private equity firms, these smaller firms seek out opportunities for growth on their behalf. By diversifying with multiple private equity funds, who each diversify with several small companies, a fund of funds can take advantage of inverse relationships in the markets.
To help you understand the “private equity fund of funds” concept a little better, we have provided a diagram below. Scroll down and take a look at the picture, along with the explanation which follows it.
In the picture above, you can see that the “Private Equity Fund of Funds” is spreading it’s capital amongst “Private Equity Firms A-J”. Once the capital is on the books of firms A-J, they will invest with different companies, strategies, risks, and goals. At the time when the yields are paid, the Private Equity Fund of Funds takes out it’s management fee and returns the net profit to the investor. In many cases, the “Investor” may reinvest the profits with the fund of funds, which restarts the same cycle all over again.
As you can see, the “fund of funds” strategy may be different, but it has become very popular for a reason. Though the structure may inherently protect investors more than a normal private equity firm, remember, your success depends SOLELY on the fund manager (“General Partner”). If you do choose to invest with a fund of funds, make sure they are diversified amongst several investment strategies, markets, geographies, and histories. The fact is, if a fund of funds isn’t accomplishing proper diversification, it is no better than a regular private equity firm!
We hope you enjoyed this great article on the “fund of funds” strategy, and it’s place in the private equity market. To learn more on private equity investing, visit our “Related Articles Section” below. As we all know, education is EVERYTHING, especially in the alternative investment world…
InsideTrade LLC Staff
Phone: (949) 444-2111