Why Fund of Funds Investing is the Smarter Choice for Your Portfolio

July 31 2023

Why Fund of Funds Investing is the Smarter Choice for Your Portfolio
Private equity (PE) investments have long been considered exclusive opportunities available only to institutional investors and ultra high-net-worth individuals. The high minimum investment thresholds associated with traditional PE funds have made it challenging for individual investors to participate. However, Private Equity Fund of Funds (PE FoFs), including Vantage Asset Management, provides investors with a solution that makes PE investing more accessible to a broader range of investors.

In this article, we will explore how the PE FoF structure provides investors with access to a once inaccessible market, and the benefits of adding Private Equity exposure to your investment portfolio.

The Democratization of Private Equity
As alluded to above, access to Private Equity has historically been restrictive, limiting itself to investment from institutional or ultra-high net worth individuals due to its high minimums, often greater than $10 million for top quartile performing funds. Private Equity Fund of Funds, including Vantage Private Equity Growth Funds, challenge the status quo by breaking down the traditional monetary and non-monetary barriers to entry. We have explored a few of these barriers below:

Low Minimum Investment: One of the primary obstacles individuals face when investing in private equity is the high minimum capital requirement, making it inaccessible for many investors. However, private equity fund of funds offer a solution by pooling funds together to reach the required entry point. This collective approach allows individuals to participate in PE investments with significantly lower entry points, often as low as $100,000 in the case of Vantage Funds.

Established Relationships with Managers: Furthermore, entering the private equity market often requires established relationships with fund managers. These relationships are built over time and can be challenging for individual investors to develop. Investing with an established private equity fund of funds offers investors the opportunity to leverage the investment team’s existing relationships and gain access to a diversified private equity portfolio consisting of 8-10 private equity funds, each with 6-8 underlying investments, as opposed to a single allocation to one manager. Vantage’s Investment Team have extensive networks and experience in the Australian and New Zealand private equity industry, allowing them to have access to top-quartile funds that may not be accessible to individual investors. This removes the need for individual investors to build relationships from scratch with private equity managers over an extensive period of time and provides access to a wider range of private equity investments.

Shifts the responsibility of manager due diligence requirement to the FoF: In addition to accessing top-tier funds, investing with private equity fund of funds also alleviates the burden of conducting individual due diligence on each underlying private equity fund, which can be a complex and time-consuming process. However, by investing in a fund of funds, investors delegate the due diligence responsibility to the fund’s experienced investment team. Vantage’s team have the expertise and resources to conduct in-depth due diligence on the underlying funds and their managers, assessing their track records, investment strategies, risk management practices, and alignment with investor goals. The Investment Team is complemented by the Investment Committee, who are independent of the investment team with substantial business, finance, and private equity expertise who oversee investment decisions. This shift in due diligence responsibility allows individual investors to benefit from the fund of funds’ comprehensive diligence process, and their ability to effectively monitor underlying funds and their managers.
Investing through private equity fund of funds democratizes access to the asset class, enabling a broader range of investors to participate and benefit from the potential advantages that private equity investments can offer to an investment portfolio.

How does Private Equity fit into an Investors’ Portfolio?
Building a robust investment portfolio requires careful consideration of different asset classes that can provide a balanced blend of returns and risk management. In this regard, private equity emerges as a compelling component that can enhance portfolio performance. Below, we will explore how private equity exposure can effectively contribute to an investor’s portfolio, focusing on two key factors: its potential for outperformance and high returns, as well as its role in minimizing risk through diversification. By delving into these factors, we can uncover the value that private equity brings to a portfolio and understand why it is increasingly sought after by investors seeking to optimize their investment strategies.

Private Equity Outperforms
Private equity has consistently outperformed traditional asset classes, making it an enticing choice for savvy investors looking to optimize their portfolios. The allure of private equity lies in its ability to generate robust returns that surpass those achieved through public equities or other traditional investment avenues. The below diagram depicts the value of $1 invested into Private Equity in 2017 against public equities, private real estate and private credit over the same horizon, showing a clear outperformance of PE.

Source: Hamilton Lane Data via Cobalt, Bloomberg (January 2023)

We’ll delve into why we believe private equity outperforms and explore the factors that drive its success. By understanding these key drivers, we can gain insights into the unique advantages that private equity offers and why incorporating it into an investment portfolio can be a prudent decision for long-term financial growth.

  • Timing: PE investors have the flexibility to time their entry into and exit from investments. Unlike public equities, private equity funds can execute investments opportunistically and conduct due diligence for months before committing capital to a new investment, or alternatively waiting for the right conditions and opportunity to arise when seeking an exit. This ability to act decisively and patiently allows private equity funds to seize unique opportunities that may not be available to most public markets managers.
    Control: PE investors tend to have a higher level of control over their investments compared to public equities, with PE managers often taking controlling stakes ranging from 40-100% of equity versus the minority, non-controlling interests typically held by public equity managers. In PE, this control allows investors to actively engage with portfolio companies, influencing strategic decisions and implementing value-creation initiatives. This level of involvement allows PE investors to unlock additional value and generate superior returns.
  • Lack of pressure to generate short-term returns: Private companies are not constrained by the ongoing return requirements of public markets. Public market investors typically seek consistent, linear growth in their investments which impacts how these companies are managed – whereas PE managers can implement longer-dated value creation strategies without the burden of having to generate short-term value for investors, unlocking significant upside potential that can generate returns for investors at exit.
    Unique and broad opportunity set: PE investors have a much larger range of investment opportunities compared to public market investors. The volume of unlisted, private companies far outnumbers listed equivalents. To illustrate this, as at 30 June 2022, there were ~2.6 million private businesses trading in the Australian economy according to the Australian Bureau of Statistics compared to 2,158 ASX-listed businesses at the same time. Although a significant portion of these unlisted businesses would not fall into the scope of private equity (due to size), the advantage is clear – private equity investors are not restricted by the availability of investment opportunities. We’ve also seen an increasing number of public to private transactions in recent times by PE managers, expanding the opportunity set further to include currently listed businesses.

At Vantage’s core, our strategy is driven by our ability to select high performing private equity managers that recognise these drivers and can leverage them to generate superior returns for investors.

The Diversification Angle
An essential aspect of constructing a durable investment portfolio is diversification, which involves spreading investments across asset classes with low correlation to reduce risk. In this regard, private equity exposure plays a crucial role, offering a unique avenue for diversification that goes beyond traditional asset classes. By incorporating private equity into their portfolios, investors can achieve a lower level of risk and enhance the overall stability of their portfolio. With the uncertain economic outlook, diversification is the largest controllable hedge to volatility in an investors portfolio. From this perspective, we see two core diversification benefits that arise from PE FoF exposure in a portfolio:

  • Diversification through Private Equity as an asset class: Private equity exhibits a low correlation with other asset classes such as stocks and bonds. This low correlation provides a valuable source of diversification, reducing overall portfolio risk. By including private equity exposure in a portfolio, investors can enhance risk-adjusted returns through exposure to an asset class that typically behaves differently from traditional investments.
  • Diversification within Private Equity (multiple managers and multiple investments): Diversification is further enhanced within the private equity asset class itself. Private equity fund of funds invest in multiple private equity managers, spreading the investment across a range of vintages, financing stages, manager strategies and industry sectors. This diversification within the private equity space mitigates the risk associated with relying on a single fund or manager and reduces the overall risk of the portfolio. For example, Vantage Private Equity Growth 2 (VPEG2) and Vantage Private Equity Growth 3 (VPEG3) have exposure to 55 and 50 companies respectively, operating in a range of industries including Technology, Healthcare, Consumer Staples, Agricultural Products and Industrial amongst several others. These exposures are gained through a combination of primary fund commitments to Private Equity managers and co-investments and have the effect of limiting the impact of macroeconomic cyclicality on the performance of the portfolio.

The below graph ties together our discussion, clearly illustrating the benefits of private equity. It depicts the notion that private equity exposure in an investment portfolio has the effect of reducing risk (horizontal axis), while increasing annualised returns (vertical axis). We’ve observed this in the market, as larger institutional players increase their allocations to private equity, while an increasing number of individual investors are actively seeking to gain this exposure and reap its benefits.

Source: Neuberger Berman, FactSet

So what’s next?
As investors seek to optimise their portfolios and navigate an ever-changing investment landscape, private equity exposure presents itself as part of the solution, offering superior returns while minimising risk. Through the democratization of private equity via a fund of funds (FoFs) like Vantage Funds, individual investors can now access an asset class that was once limited to institutional investors and ultra-high-net worth individuals.