Fund of funds

Funds of funds have historically been one of the primary tools used by institutional investors to build diversified exposure to private markets while benefiting from the expertise of multiple investment teams.

How does a fund of funds work?

The principle is relatively simple.

Traditional fund

A private equity fund invests directly in unlisted companies.

Fund of funds

The fund invests in several private equity funds, which in turn invest in companies.

The investor is thus exposed to several underlying portfolios managed by different market participants.

This structure provides an additional level of diversification compared to investing in a single fund.

Why invest through a fund of funds?

Funds of funds were developed to address several challenges faced by investors.

Access specialized fund managers

The best private equity funds are often difficult to access and may limit the number of investors they accept.

Funds of funds allow for the consolidation of multiple strategies within a single investment vehicle.

Diversify risks

The portfolio is diversified across multiple managers, sectors, geographic regions, and vintages.

This diversification reduces reliance on the performance of a single fund or company.

Pooling expertise

Fund selection is generally based on a thorough process of analysis, due diligence monitoring.

Investors thus benefit from the expertise of professionals who specialize in selecting fund managers.

How are the funds selected?

Building a fund of funds requires a significant amount of analysis.

In particular, management teams evaluate:

Historical performance

Analysis of IRR, TVPI, ROE, and other performance metrics.

The quality of the teams

Experience, stability, and organizational structure of management companies.

The Investment Strategy

buyout, growth equity, venture capital, or specialized strategies.

The ability to create value

Investment methodology, business support, and track record of value creation.

The goal is to identify fund managers who are likely to generate attractive returns over the long term.

What are the advantages of a fund of funds?

Immediate diversification

Through the underlying funds, investors gain exposure to dozens, or even hundreds, of companies.

Reduced selection bias

Performance depends less on a single fund or a single management team.

Access to institutional asset managers

Funds of funds can provide access to opportunities that have traditionally been reserved for institutional investors.

Simplified management

Investors benefit from a single subscription process and centralized monitoring.

What are the risks associated with a fund of funds?

Risk of capital loss

As with any private equity investment, the capital invested is not guaranteed.

Liquidity risk

The underlying investments are generally held for the long term.

Selection bias

Performance depends directly on the ability to select the right funds.

Complexity of Valuations

The portfolio is based on aggregate valuations derived from numerous underlying funds.

Funds of funds and diversification

One of the model’s main advantages lies in its ability to diversify across multiple dimensions simultaneously:

Diversification of fund managers

Several asset management firms are represented in the portfolio.

Diversification of strategies

buyout, growth equity, venture capital, or other segments of the private markets.

Geographic diversification

Europe, North America, and other international markets.

Time diversification

Investments made over several vintages.

This approach explains why funds of funds have historically played a significant role in institutional investors’ asset allocations.

Funds of Funds and Institutional Private Equity

For several decades, pension funds, insurers, foundations, and family offices have widely used funds of funds to build their private equity allocations.

This approach allowed them to:

• Access to top-tier fund managers;

• Pool recruitment resources;

• To build a diversified exposure to private markets.

Even today, funds of funds remain a key pillar of institutional private equity.

History of funds of funds

1980s–1990s: The Rise of Institutional Private Equity

Investors are looking for solutions that allow them to access multiple funds through a single structure.

The 2000s: Market Globalization

Funds of funds are growing rapidly as the private equity industry becomes more global.

Today

They remain widely used to gain exposure to diversified strategies in private markets.

Funds of funds and access to private markets

For many investors, a fund of funds serves as a gateway to private equity.

It provides access to a portfolio comprising multiple managers, various strategies, and numerous unlisted companies, all while benefiting from a professional selection process.

This logic explains why funds of funds remain one of the most widely used vehicles for building diversified exposure to private markets.

FAQ

What is a fund of funds?

A fund of funds invests in multiple investment funds rather than directly in companies or assets.

Why invest in a private equity fund of funds?

It provides access to multiple managers, strategies, and portfolios within a single investment vehicle, while enhancing diversification.

Does a fund of funds invest directly in companies?

No. It invests in funds, which in turn make direct investments in companies.

________________________________________

Disclaimer: Investing involves the risk of capital loss. Past performance is not indicative of future results. The information presented in this article is intended solely for educational and informational purposes. It does not constitute investment advice or a recommendation to buy or sell any financial instrument.