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How’s it going? Today, I’m going to explain how a fund of funds works!
What?
The structure of the fund of funds is just like any other fund.
There is the GP (you, the fund manager) and the LP (fund).
The difference is that instead of investing in real estate or private equity, you are investing in other funds (it’s in the name)!
Like I illustrated in my video, here’s what the structure looks like:
Why?
So, why would the investor go with the fund of funds instead of the other funds themselves?
Investing in the fund of funds would diversify your portfolio. Here’s an example:
There is a risky VC fund that is expected to get a 40% return. This fund makes up a fraction of a fund of funds. The minimum investment amount is $2M, but you only have $2M to invest.
It would be wise to invest in the fund of funds as this investor because with your $2M, you would be invested in this VC fund and a handful of other PE and RE funds.
How?
So, as the GP, how do I charge fees if there are so many LPs involved?
The best way is to reverse engineer your deals. This means you look at the returns from each LP and figure out which percentages make sense. Don’t give all LPs the same fees; all funds are not created equal.
Keep in mind that investors will be charged 2 separate fees because of the fund of funds structure. It can still work in their best interest, but make sure to disclose everything!
So far, we’ve covered 2 benefits to investing in a fund of funds. Let’s explain the 3rd:
- Accessible for investors
- Diversification in investors’ portfolio
- The fund manager has negotiating power
Because the capital helps the LPs so much, you could negotiate with them. For example, in exchange for X amount of dollars invested in their fund, you could receive a 1% discount in management fees.
One last benefit for fund of fund managers…
After the fund is set up and the processes are running, you have some free time!
Just make sure everyone is getting paid (and other minor things) and you’re chilling for the next 7-10 years!
Conclusion
So, how do fund of funds work?
Instead of a fund that invests in just RE, PE, or VC, you get a piece of everything! Once fees and capital distribution are set up, the fund manager can negotiate discounts and rest easy!
Click here if you want help starting your own fund!
That’s it for today!
Thanks,
Want to get direct guidance for your fund? Schedule a time with my Fund Advisors!
DISCLAIMER: This content is for educational and informational purposes only. It is not to be taken as tax, financial, or legal advice. You should always consult a legal professional before taking action. Furthermore, this is not a recommendation to buy or sell any security. The content is solely just the opinion of the authors.
