Private Equity Fund of Funds vs. Direct Investing

There are private equity funds of funds that invest in individual private equity funds just in the same manner as hedge fund of funds invest in other hedge funds.  There are some advantages in using a fund of funds to invest. There are two primary costs involved as well.  Investors in funds of funds have to pay for two layers of management fees.  They have to pay the private equity fund and the fund of funds.  The other cost is the double layer of carried interest / performance fees.

What do investors get by going through funds of funds?  They get a diversified portfolio of different managers with, hopefully, different investment strategies.  Funds of funds managers can give smaller investors access to an investment with a large minimum commitment amount by pooling their capital.  They provide research, do due diligence, monitor investments and manage liquidity.  They give investors access to top quartile funds that would not be possible for new investors.  They make the fund raising process easier for fund managers by having a ready group of investors.

In order to pay the additional layer of fees, the fund of funds needs to outperform direct investors by 0.7% to 3.4%.