the challenge with fund investments
'Upper quartile' funds in alternative asset classes (Private Equity, Private Debt, Real Estate and Infrastructure) have consistently shown the ability to deliver accretive and uncorrelated performance to large, well-diversified investment portfolios. Designed with large institutional investors in mind, however, the limited partnership structures they typically employ are not well suited to the needs of family offices and UHNW investors for the following reasons:
- Fund's 'blind pool' nature and long investment periods mean that decisions to back or 're-up' with a particular manager are typically only made once ever 3-5 years. The best managers often have minimum commitment amounts of $10m or more.
- Limited Partners' are expected to maintain significant liquidity reserves in order to meet substantial capital calls at short notice. Track records and other historical or projected performance measures of a particular fund cannot take this 'opportunity cost of liquidity' into account.
- The majority of capital committed by LPs is typically only returned towards the end of a fund's 10-12 year life; earlier access to liquidity requires resorting to opaque secondary markets, where illiquid limited partnership interests can trade at substantial discounts in periods of macroeconomic dislocation.
co-investments vs. fund investments
Co-investments alongside these same 'upper quartile' managers provide a potentially attractive alternative as follows:
- The higher velocity of investment opportunities provide a more dynamic way to adjust one's portfolio as the macro environment and other factors change over time.
- Investors decide where, when and how much to contribute towards a particular deal, whenever it suits them, taking into account their current liquidity needs.
- "Piggy backing" on a lead manager's due diligence can substantially lower an LP's execution costs required to complete an investment.
- Typical holding periods average closer to 5 years, and lower contingent 'committed capital' reserves mitigate the requirement to access secondary markets for liquidity in times of financial stress.