“We’ve seen a few being launched, but it’s not an asset class where investors have really required funds of funds,” says Justin Mallis, a principal at placement agent First Avenue. His is a sober assessment of private debt funds of funds, backed by PDI data which show the model has not gained significant traction with investors.
One of the most obvious reasons is an unwillingness to pay a double layer of fees, especially given many private debt strategies’ returns are relatively modest, compared with asset classes where funds of funds have become popular.
Market observers also make the point that the consultants advising limited partners on allocations have tended to beat funds of funds to the punch. The double fee layer does not apply to them and some consultants – the likes of Wilshire Associates and Aksia were mentioned to PDI – have become adept at providing clients with niche exposures through discretionary or separately managed account type arrangements.
Another factor is that, in private equity for example, funds of funds offer the possibility – through carefully cultivated relationships – of gaining access to funds for which there is an extremely high level of demand. This ‘value-add’ is rarely available in private debt.
“In private equity there is a scarcity factor, with firms that are really good capping the amount they want to raise. In private debt, funds keep upping the amount of capital they want to raise in successor funds, so the scarcity factor does not apply,” says Mallis.
Related to the value of access to the best funds, the difference between the best and worst performing vehicles tends to be much greater than in private debt and, therefore, the consequences of making bad allocation decisions are amplified. Investors in private equity may well be happier to outsource that responsibility to a fund of funds.
One market which appears to be bucking the trend is Germany, where investors have been slow to commit to private debt but where they are now waking up to the opportunity.
“I firmly believe there is a place for funds of funds in Germany because there are many institutions that don’t have the manpower or the strategic objective to build an internal resource,” says Boerge Grauel, a managing director at Munich-based Golding Capital Partners, which offers funds of funds as part of its product offering.
With German investors facing various obstacles to invest in private debt, outsourcing to a funds of funds manager can be a way of dealing with the complexity.
Deborah Zurkow, head of alternatives at Allianz Global Investors, points out that private debt is still a young asset class and expects to see more funds of funds in future.
“There is still a lot of fundraising in primary funds and LPs are pretty savvy in terms of getting the exposures they want and achieving diversification,” she says. “But, over time and with market growth, we will see an increase in the number of investors looking to funds of funds to create the diversification for them. They can see what’s happened in private equity and it’s inevitable we will see more moves in that direction.”