Last time around, we went through Part 1 of the confusion around PE funds of funds: what they actually do, what the work consists of, and how the recruiting process and case studies in interviews work.
Our interview picks up today with Part 2, where we delve into the industry landscape, what you do on the job in more detail, and the usual “no B.S. discussions” you’ve come to love about the real trade-offs of the job.
Let’s get started by breaking down the funds of funds industry, see where different firms fit in, and how to tell which places to avoid:
Industry Landscape & Overview
Q: So what’s the funds of funds industry like overall? Are there a lot of independent shops, or are they mostly part of larger banks or investment firms? What about industry or geographical focus?
A: Most places are actually independent, and that’s becoming more and more true over time because of the Volcker rule and how bulge bracket banks are spinning out their investment arms into separate firms.
A few of the biggest US-based, independent firms: Adams Street Partners, Pathway Capital, and HarbourVest Partners. Among banks, Goldman Sachs has the biggest internal PE fund of funds.
These funds don’t focus on particular industries or geographies because they all want to be diversified – that’s the point of investing in dozens or hundreds of PE funds, after all.
Q: I see. So what is the typical AUM of a fund of funds? And what about the investment team size?
A: They’re definitely much smaller than traditional direct investment PE funds. I don’t have the exact numbers for every fund, but the biggest (general) funds of funds worldwide might have close to $100 billion USD in AUM; those in the Top 20 might have in the tens of billions USD.
You don’t really see “small” funds of funds because you need a certain level of AUM to invest in a portfolio of PE (or other) funds to begin with; maybe there are a few with under $1 billion USD in AUM, but they are the exception rather than the rule.
Team-wise, smaller funds of funds might have an investment team of 25-50 people, and sometimes as few as 10-20 professionals. The biggest funds might have more like 100-200 investment professionals – sizable, but still smaller than what you see at the biggest traditional PE funds.
I would be surprised if there were more than a few thousand professionals total in this industry in the US – and that count is probably not above 1,000 by much.
Q: Well, I think those are more specific numbers than almost any other interviewee has ever guesstimated, so props to you.
Anything else we should know about the industry?
A: In my mind, it’s a bit of a dying industry because PE firms are having trouble raising capital currently; they might just bypass funds of funds directly and go directly to the Limited Partners to make the process faster.
That’s not to say that PE funds of funds will actually “die” anytime soon – it’s just that these funds are strongly linked to the strength of private equity performance and ease of fundraising, which both vary over time.
One other point: if you’re deciding on which fund of funds to go to, you need to dig into their deal flow and determine whether or not the fund has dry powder.
It’s not too much fun to join a fund of funds that is 90% invested and isn’t planning to raise capital again anytime soon, because you won’t get much investment experience.
And it’s better to go to a place that does more co-investments so you get the modeling skill set that traditional PE firms are looking for.
A Day in the Life of a PE Fund of Funds Analyst
Q: Thanks for those tips, and way to be optimistic there with the “dying industry” bit!
Can you walk us through an average day in your life?
A: At most PE funds of funds, you’ll work from 9 AM to 7-8 PM, so maybe 50-55 hours per week.
But this varies by fund, and I’m currently working more like 7-8 AM to midnight on weekdays – closer to banking hours.
Q: OK, so this doesn’t really sound like “half the hours” of traditional PE, though you maybe it is an improvement.
A: Yeah, as I said, it really varies by the fund, where they are in the investment / fundraising cycle, and their investment strategy.
At any given time, here’s what I’m usually working on:
- 3-4 PE fund investments
- 1-2 co-investments (traditional LBO deals)
- Quarterly client calls and portfolio reviews
- Ad hoc client requests such as industry reports and attending conferences
Here’s how I spend my time overall:
- Fund Investments: 50%
- Co-Investments: 30%
- Client Requests: 20%
But this breakout depends on the analyst and the fund – some people here who have stronger technical skills spend more like 80% of their time on co-investments and 20% on everything else.
Q: So what exactly creates those long hours you’re currently working? Is it all because of the co-investments?
A: Yeah, exactly – it’s mostly because we have to meet the deadlines of PE shops and clients and act as a liaison to both parties.
They might come to us and say, “We’re buying this company and the deal is closing in 2 weeks – give us a yes/no answer on whether you want to co-invest by then.”
So that creates a bit of a frantic cycle where we have to do the technical and modeling work, conduct our own due diligence, make dozens of reference calls, look at the proposed debt, and do everything else quickly (there’s no reason to involve us before that since most deals fall apart in the early stages).
Client and prospective client work makes this worse as well – many LPs such as public pension funds, corporate pension funds, and family offices now perceive private equity to be “more stable” than the public markets, so they’re approaching us and asking about investing in the sector.
Q: But I thought you said earlier that it’s a “dying industry.”
A: Well, more in the sense that PE funds may not turn to funds of funds to raise capital as much in the future.
But there’s still plenty of interest in investing in those PE funds, whether directly or indirectly (through us).
Q: So it sounds like another case of “too much money chasing too few good deals”… not too surprising.
In Part 1, we talked briefly about the technical and modeling skills that are required and how you analyze PE funds rather than the underlying companies.
Did you want to add anything to that?
A: Not really, it’s pretty much what we talked about before. The main differences:
- As I mentioned, we spend time valuing the entire portfolio of PE funds and seeing if there are any discrepancies. We also pay a lot of attention to distributed funds, realized vs. unrealized gains, and the consistency of the returns over time. Most importantly, since we are investing in a blind pool, we need to have strong conviction on the team.
- Benchmarking is very important – we might look at several hundred funds each year and benchmark a fund from a given year against all other funds from that year either through public resources or internally against other funds in our pipeline.
- On co-investments, you don’t get quite as much exposure to the debt side because the PE fund directly negotiates for and arranges the debt with the lenders. Sometimes we do provide input and introductions to bankers, though.
But there is another point I want to raise: your social skills are also very important in this job.
In fact, it’s even truer here than in traditional PE because you go to conferences and meet Partners at funds and C-level executives quite often.
In traditional PE, yes, you may have to cold call companies and work in a team, but your “presentation skills” don’t necessarily have to be as polished.
Q: So you just brought up an interesting point there… how much exposure to these Partner/Founder types and C-level executives do you actually get?
A: Quite a lot – in fact, that’s probably the best part of this job.
I’ve met Partners at all types of PE funds because they’re always going around fundraising. I even got to meet one of the founders of Blackstone.
Outside of that, I’ve met with the management teams of many companies and a lot of our own Limited Partners as well. Even as a junior person here, you’ll call CEOs of PE firms’ portfolio companies, help with reference checks, and more.
There’s some “senior supervision,” but they’ll generally tell you, “Go to this conference, meet people, and report back to us” and won’t micro-manage anything.
Q: You mentioned getting to meet Partners at private equity firms when they come in to pitch you on their new funds – how do you evaluate that?
In other words, what makes a “good pitch” vs. a lackluster pitch when you’re analyzing these funds?
A: A lot of it goes back to what we talked about in Part 1: consistent returns over time, minimal unrealized gains propping up the portfolio’s value, and a team that has been together a long time.
But in a pitch itself, the firm’s differentiated strategy is really important. It’s just like how you need your own “hook” to stand out in interviews. Examples:
- Do they focus on a certain sector in the market (e.g. middle-market software companies with revenue between $50 million and $250 million)?
- Are they industry experts on something that requires deep technical knowledge, like oil & gas?
- Do they have a lot of operational experience with specific portfolio company strategies and improvements?
Remember that a PE fund of funds itself is diversified – so we’re looking to invest across many more specialized PE firms.
A compelling strategy might be: “We specialize in buying out E&P companies with between $1 billion and $5 billion in revenue and using our consultants and operational turnaround experts to move the firm into unconventional energy reserves and reduce their cost basis.”
In terms of teams, here are examples of what we’re looking for:
- If you’ve worked together for 20 years across all sorts of different market conditions, that’s great (this rarely happens, of course).
- If you’re starting a new fund, ideally you will have all worked together at the same previous fund (e.g. 3 Partners who worked at Blackstone and then set up their own shop). It’s harder to tell your story if you and your Partners are all coming from different firms.
- Do you have skin in the game? I’m not referencing Nassim Taleb just for fun here: it will raise eyebrows if you and your Partners are raising a fund but you’re not contributing any of your own personal funds.
- Is your strategy repeatable? If your first fund was $200 million and you did well with a certain industry and company size, that’s great, but if your second fund is now $1 billion that’s a totally different ball game. The investment size will increase, the competition will be different, and you will almost certainly have to expand your team, which carries with it additional risk.
Q: So it sounds like it would be very difficult for a group of Partners to come to you with a completely different strategy or fund size and raise capital for a new fund.
A: It’s not impossible, but it is more difficult – at least from the perspective of a fund of funds.
We favor funds that are consistent in terms of size and investment types – and something like expanding 5x and hiring additional team members would be cause for concern.
And, of course, if this is your first fund with no track record, you won’t have much luck pitching funds of funds. You’re better off starting small and going to other Limited Partners, your own capital, and other sources initially.
Analyst Meets Limited Partner: Got Cultural Clashes?
Q: I’m very curious what the culture and hierarchy are like at your fund, because so far this sounds like a very “mixed” role where you’re working in many different capacities.
A: Sure… your question about the hierarchy is easier to answer, so I’ll start with that. It’s the same as what you see in IB or PE: Analyst, Associate, VP, Principal, and Partner.
The difference is that rather than being promoted directly or “moving to the buy-side” (since they’re already on the buy-side), Analysts here often go to business school or even take the CFA before moving up.
Culture-wise, people are fairly aggressive overall but it’s still more of a “team environment” than a typical bank.
The main reason for that: we need to leverage a lot of relationships with different funds, LPs, portfolio companies, and so on, and no single person knows all these people everywhere.
Relationships also matter in PE and banking, of course, but you specialize more there so you may not have to depend on other people at your firm quite as much.
Here, on the other hand, someone might be an expert on real estate, distressed funds, mega-buyout funds, or anything else, and we have to lean on their knowledge. Also, there are no separate pools of capital for different groups at my firm.
You still see office politics here: people are competitive, everyone wants to advance, and since funds of funds tend to be smaller, there is a lot of pressure to reach the Partner-level – otherwise there’s little point in staying on for the long-term.
The main difference is that on the buy-side you must perform to move up – yes, in banking there is also a performance component, but you can also move up at the junior levels without necessarily sourcing deals or bringing in new business. That would be almost impossible here.
So you’re judged heavily on your investment ideas, the depth of your relationships, and your ability to fund raise and conduct “investor relations.”
Finally, one last point: sometimes there are more females at PE funds of funds than in other areas of finance because you don’t need to travel quite as much, so having a family is more feasible.
Q: That’s a great description of funds of funds vs. banking and private equity… now to my favorite topic: the pay.
Let’s hear it.
A: The pay is in between investment banking and private equity compensation.
I don’t want to give exact numbers, but my base salary and bonus were both in the $70-$100K USD range as an analyst here last year.
From what I can tell, that was the middle of the bonus range here. Top-performing analysts might see 100-130% or even up to 140% of their base salaries for their bonuses.
One caveat: I’ve heard from colleagues that my particular group “pays well,” so my guess is that you’d see lower pay elsewhere, and especially at non-PE funds of funds.
Q: And senior people, such as the Partners at the fund, also get carry?
A: Yes, it’s similar to traditional PE there. You might even get carry at the level below that, as a Director or Principal.
Your compensation is even more performance-dependent than in other fields because base salaries at funds of funds tend to be lower than those in banking or PE.
Some funds of funds also have hurdle rates before carry “kicks in,” so that’s another factor to consider… but it’s also similar to how many PE funds work.
The Future: Robust Growth Expectations?
Q: So let’s say you work at a PE fund of funds for several years and then decide you want to “make an escape.”
What are your exit opportunities?
A: The two most common exit opps are pension funds and traditional, direct investment private equity funds.
Some people claim that you’ll earn more in traditional PE but also work more, whereas you’ll work less and make less at pension funds, but I am not so sure of that – I’ve seen mixed results and people at both types of funds tend to work a lot. So that’s probably not the best way to compare them.
Lots of people here go to business school and then join a direct investment shop afterward.
Q: I am surprised that that many people go into direct investment PE firms right afterward – what if you don’t work on many co-investment deals?
A: Yeah, that makes it more difficult, but you can learn those skills elsewhere.
You have one big thing going for you after working at a fund of funds: contacts at potentially thousands of PE firms and other investment funds that act as Limited Partners to PE firms.
In fact, you might even end up with more contacts as a junior person than many Partners at a direct investment firm would have.
They remember your name because you’re their source of capital. You might not be as good at sourcing direct investments as someone who had worked in PE before, but the access you have can more than make up for that.
Q: Well, that makes more sense now.
So based on everything we discussed so far, who would fit in best with the group? And who would be a bad fit for these roles?
A: You need to have solid technical skills, but you don’t need to be an elite modeling wizard to succeed.
On the flip-side, though, if you can’t do much number-crunching at all this is the wrong role for you.
Aside from that, you should:
- Be presentable and be good at speaking with potential clients and building long-term relationships – sometimes it takes us years and years to raise the amount of capital we need.
- Have a good sense of the market itself and be comfortable with a more “tops-down” approach. Sometimes bankers struggle with this because they’re used to analyzing specific companies, but here it’s more about the overall direction of private equity, fundraising, and valuations.
Your exit opportunities are broader than you might think, but if you want to get into direct investing private equity eventually, you really need to be at a PE fund of funds, and ideally one that makes a good number of co-investments.
I can’t think of anyone who would be a “bad fit” – but maybe if you only want to work on M&A or LBO deals and handle the technical side, this wouldn’t be the right group for you.
Q: Great, thanks for adding that.
So what are your future goals?
A: I haven’t decided yet. I definitely like where I’m at right now, and I’m very glad I made the switch over from commercial banking.
On the other hand, I’m not sure if funds of funds have a great future in general, so I’m considering hedge funds and other asset management firms, and I might go to business school in between.
Q: Awesome. Thanks for your time!
A: My pleasure. This site was my “Bible” when I was recruiting, so I wanted to give something back!
Private Equity Funds of Funds – Series