Primary investment refers to private equity funds investing in newly established private equity funds during their fundraising period. It is the originating and fundamental strategy of private equity fund of funds (PE-FOF). As private equity continues to gain popularity among investors, primary investment remains an essential strategy for PE-FOF to achieve diversification and long-term stable returns.
For PE-FOF managers, primary investments allow them to build in-depth partnerships with top-tier private equity firms and gain access to quality deal flows. The scale and professional network of PE-FOF also makes them preferred LPs for many private equity funds’ fundraising. Through careful selection of GPs and thorough due diligence, PE-FOF can construct a balanced portfolio across strategies, geographies, industries and vintages via primary investments.
In this article, we will explore the key aspects of primary investments in private equity and how it benefits PE-FOF.
Primary Investment Enables Portfolio Diversification for PE-FOF
The major advantage of primary investment for PE-FOF lies in portfolio diversification. By investing into 10-20 newly established private equity funds across strategies, geographies and industries during their fundraising period, PE-FOF can effectively mitigate the concentration risks associated with investing into any single private equity fund.
For instance, the poor performance of one particular GP or industry will not significantly drag down the overall returns of a diversified PE-FOF portfolio constructed via primary investments. The failures can be offset by the outperformers. According to studies, compared with single private equity fund investments, the risk-adjusted returns of primary focused PE-FOF are generally higher and more stable.
Furthermore, primary investments into funds with different vintage years can smooth the J-curve returns for PE-FOF and minimize the impacts of macro-economic cycles. The long-term and illiquid nature of private equity investments calls for vintage year diversification in order to generate consistent performance.
Primary Investments Enable PE-FOF to Forge Strategic Relationships with Top Fund Managers
In addition to diversification benefits, primary investments also allow PE-FOF to establish in-depth partnerships with top-tier GPs in the industry. PE-FOF serve as committed LPs for these GPs’ new funds, and the long-term alignments foster stronger relationships and collborations.
As a professional and knowledgeable LP, PE-FOF often hold advisory board seats and maintain close communications with GPs. When attractive investment opportunities arise, PE-FOF are likely to gain privileged access. Furthermore, the connections enable PE-FOF to better understand GPs’ strategies and operations, conducting rigorous due diligence during primary investment stage.
The strategic relationships with GPs form the foundation for PE-FOF to source quality secondary deals and co-investments to augment returns. Hence primary investment remains the cornerstone strategy for PE-FOF, providing channels to unique deal flows and partnership networks.
Primary Investments Allow Disciplined Portfolio Construction for PE-FOF
As long-term investors with 10+ years investment horizon, PE-FOF emphasize portfolio construction discipline and consistency during primary investment activities. Diversification across strategies, geographies, industries and vintage years is implemented at the onset through thoughtful primary investments.
Such discipline guards against overconcentration risks and style drifts. It provides PE-FOF with clearer paths to build institutional-grade portfolios capable of balancing returns and risks. As private equity investments become more mainstream, PE-FOF’s portfolio construction expertise and access via primary investments are increasingly valued by LPs.
Moreover, the scale of PE-FOF also allows them to make meaningful allocations tuned to GPs’ fund sizes during primary investments, whereas smaller LPs may find it difficult to deploy capital in a focused manner.
In conclusion, primary investment lies at the core of private equity fund of funds’ strategy. It enables portfolio diversification, strategic GP relationships and disciplined portfolio construction for PE-FOF. Primary investments would retain its importance for PE-FOF going forward given the continuing proliferation of private equity funds and the needs for professional LPs.