Private equity fund of funds (FoFs) have always been a topic of debate. At first glance, they seem like an unnecessary middleman — why not just invest directly in private equity? But as with most things in finance, the reality is more nuanced.
For many investors, particularly those lacking the resources to source, evaluate, or scale into top-tier funds, FoFs offer a smart workaround.
At their core, PE FoFs act as a bridge between investors and PE firms, essentially operating as Limited Partners (LPs) for private equity firms. They raise capital from institutional investors — pensions, sovereign wealth funds, endowments, and high-net-worth individuals — and invest that capital into a diversified portfolio of private equity funds.
Unlike traditional PE firms that invest directly in companies, fund of funds managers spread capital across multiple private equity funds, aiming to smooth out risk while maintaining exposure to the asset class.
The catch? All this convenience comes at a cost — extra fees. This added layer of investment management has drawn criticism from investors who prefer to invest directly.
Source: Moonfare | Hatteras Investment Partners
If institutional investors can already invest directly in private equity funds, why add an intermediary? It comes down to four key factors:
That said, FoFs aren’t for everyone. While they offer advantages, FoFs may be unnecessary for institutions with the scale and network to invest on their own.
Before we get into the process, let’s quickly recap the three ways investors can enter private equity:
For FoFs, one word matters most: performance.
We’ve all heard the classic “past performance is no guarantee of future results”, right? Well, when it comes to fund of funds, that’s only half the story. In fact, track record is one of the most relevant data points here.
When evaluating a fund of funds, past performance is the first filter. Unlike public markets, where returns are volatile and hard to predict, private equity funds tend to demonstrate more consistency. As a result, a manager with a strong track record is generally expected to replicate that success, reinforcing the assumption that past performance will potentially persist (TWSL).
But past returns alone aren’t enough. The next question: Can the team sustain that performance? This is where the three Ps come in — People, Philosophy, and Process.
Assessing these factors helps investors filter funds that are more likely to maintain outperformance — ensuring they’re not just coasting on past wins, but have a playbook for sustained success.
Source: Private Equity Bro
Tracking the growth of fund of funds within private equity is challenging due to fragmented reporting, but data from Preqin shows that the overall private equity market expanded from $2 trillion to nearly $8 trillion by 2023. The fund of funds segment has seen a similar trajectory, benefiting from rising institutional demand for diversified private market exposure.
Recent research from Invest Europe also provides fresh insights into listed private equity fund of funds, revealing a 49% average uplift in exit valuations compared to the last reported valuation. This suggests that FoFs may be more conservatively valued than direct investments, reinforcing their role in providing stability alongside diversification.
Source: Preqin
FoFs make sense for investors who want exposure to top-tier managers without the hassle of fund selection. But with extra fees and long lock-ups, they’re a hard pass for those who can manage their own allocations at scale.
If you want to put these concepts into practice, check out my Fund of Funds financial model. It’s a complete financial model that helps analyze FoF investments with insights into different fund types, fee structures and return expectations.
