How is Private Equity Accessed?

There are 4 discrete approaches to building a private equity portfolio. They are a direct investment program, Fund of Funds, Fund investment and Co-Investment.

Another option, Secondary Funds, is really a subset of Fund investing. Each of these approaches has advantages and disadvantages, typically related to issue like resource requirements, cost, transparency, flexibility and return potential. Approximately 80 % of all private equity exposure in North America is achieved through participation in one or more Single-Fund Partnerships, with Fund of Funds accounting for around 11%.

The direct approach is that adopted by Teachers’, OMERS, CDP and some of the other very large funds. In this approach, the fund recruits a team of private equity investment professionals and becomes its own GP, sourcing, evaluating, structuring and managing transactions on its own.

It is common for direct teams like this to manage domestic investments on their own and invest in funds managed by other GPs for their international and / or specialist exposure. Participating in other funds also presents the opportunity for Co-investments. Building a Direct team requires a large fund and a large private equity allocation to be viable.

In a Fund investment program, the investor selects single-fund partnerships managed by one or more GPs. This allows the investor to focus on GPs who have been proven to be able to deliver superior results on a consistent basis and avoid the under-performing funds. Because private equity returns exhibit very high persistence, the ability to re-invest with a proven winner is very desirable.  A Fund investing approach allows multiple managers and investment types, can be global in outlook and is free to be opportunistic. While Fund investing usually costs more than a Direct program, it costs less than a Fund of Funds program.

A Fund of Funds strategy offers immediate diversification by manager, type and style and, access to household names that might otherwise be closed, and is the least demanding of in-house resources. It also carries the least-onerous due diligence requirements. It also has the highest cost and carry, since the managers’ fees and carry are added to the fees, costs and carry of the underlying managers. Well run programs can be very successful, less well run programs can become a coalition of the mediocre.

Co-investments are used both by Direct teams and by more advanced Fund investors. In a Co-investment, the investor is offered the chance to share in an investment sourced and structured by the GP, which may or not be in the fund in which the investor participated in order to secure co-investment rights. If the investment is in the fund, and the investor really likes it, he can obtain a greater exposure to the investment than his proportional share as a fund investor. If the investment is not going into the fund, the investor enjoys the benefit of a direct investment in a situation managed by the GP, without the corresponding demand on limited resources. Co-investments can be a very effective performance enhancement to a private equity program.