Opalesque Industry Update - In its just released white paper, "What's Ahead for Funds of Funds?" Infovest21 examines the current environment for funds of funds; various ways funds of funds have been providing value; as well as opportunities, challenges and outlook for small, medium and large sized funds of funds.|
Some of the highlights of the report are:
• Large funds of funds generally agree that funds of funds can survive at the $250-500 million level but become a real business once assets under management hit the $1 billion mark.
• Consolidation over the next 12-18 months will continue at the same pace or even faster than it has so far this year. Many funds of funds have been involved in discussions.
• The conventional thinking is that the largest funds of funds and smaller niche funds of funds will survive but the medium sized funds of funds i.e. those with assets between $1-9 billion will get squeezed. However, some consultants and large funds of funds find potential opportunities with this category. Some large funds of funds are looking for medium-sized funds of funds to add on that are lean and have a stable loyal client base. They are particularly attractive if they specialize in a specific strategy, have a different distribution or a different geographic investor base.
• Funds of funds with $1-2 billion in assets, that were never the recipients of institutional assets, have leaner organizations. With assets mainly from family offices and high net worth investors, they have fatter margins. They haven't been hit with the same magnitude of outflows as the larger funds of funds.
• Valuations are considerably lower than they had been. In 2010, valuations of funds of funds were around seven times EBITDA compared with ten times before the financial crisis.
• Some industry veterans say the old multiple-of-EBITDA model now looks passé. Most of the current transactions are being done on an earn-out basis with very little paid up front. Purchasers are unwilling to pay anything other than a revenue share.
• Some large funds of funds may suffer a slow death. Many businesses will fall apart before the principals do something strategic. Many of the principals pay themselves a big salary and will continue to do so. With institutional investors increasingly allocating directly with hedge funds, a significant part of their asset flow has now been cut off. Their margins are now very thin. It's hard for them to downsize now as it will signal to consultants/institutional investors that they are having problems.
• Many are waiting for the 2007 environment to return. They can't consider a deal today because they received large bids before the financial crisis.
• Faced with this situation, some of the larger funds of funds who have been hit with big outflows are looking at strategic transactions because they can rationalize cost, it pushes assets under management higher and it ameliorates the pain of redemptions.
• Consultants and institutional investors aren't always happy with consolidation and reorganization. They need reassurance that the team, investment process and investment approach will remain intact.Often times, when a consolidation or merger is rumored or announced, consultants and institutions place both parties on a watch list until the situation clarifies which could be 18-24 months.
• Looking out five years, healthy funds of funds will need $5-15 billion to be a real player, have the ability to seed their own products and have true, have interesting diversification, have enough partnerships with managers that they can get interesting things done, and have systems available to do efficient hedging.
• The healthy funds of funds will have a diversified asset stream - an advisory business, a Fund of One business as well as a commingled fund business. They will be able to sit down with the institutional client and determine their tolerance for risk; appetite for returns; need for transparency, liquidity and reporting. They will be able to build a product specifically to meet the clients' needs.
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