For Fund of Funds to Thrive, Efficiency is Key

Thanks to increased access to private funds and the sector’s reputation for high fees, Fund of Funds is on a fundraising slide. How can firms attract capital in a tough market?

The Fund of Funds (FoF) sector has proven itself as a reliable way for investors to diversify and gain access to top-tier private funds while minimizing risk. By aggregating capital calls and leveraging industry relationships, FoF managers can help high net-worth individuals (HNWI) or smaller institutional investors target dozens of funds and hundreds of companies with a single investment.

This includes investments in funds that, in the words of a Vanguard report, “would otherwise be inaccessible to smaller or less-connected investors.” The report estimates that “replicating the level of manager access and diversification of a top-tier FoF across dozens of funds would require a portfolio of more than $1 billion.” Instead, FoF investors gain access to “improved diversification and downside protection relative to buyout and venture strategies alone.”

The global FoF market size has been valued at approximately $2.5 trillion, with North America being the largest market. The strategy has become popular enough that foreign governments, such as Qatar, and organizations like the NAACP have launched their own FoF vehicles.

Despite its reputation for lowering risk and providing increased diversification, FoF has not been immune to the fundraising issues that have affected other sectors in recent years. In fact, the numbers show a distressing trend for FoF when compared to other alternatives.

Recent fundraising issues for Fund of Funds

A December 2024 analysis by PitchBook signaled worrisome trends for FoF when compared to other types of private funds, calling the 16-year fundraising low an “existential threat to the strategy.”

While the report notes that private equity fundraising declined 10.8% over a 12-month period and venture capital fell 2.4%, the total capital raised by FoF “dipped 44.5% on the same trailing 12-month basis.”

One reason for the decline may be that one of the sector’s most significant traits is no longer the selling point it once was. FoF has been able to provide investors who “may not have enough capital for a minimum investment in a new fund raised by a huge firm” with the ability to invest in the best private funds by pooling their capital.

But thanks to the retailization trend, HNWI may be gaining some of the access they previously lacked, erasing the need for FoF to provide it. As stated by PitchBook, “the emergence of evergreen and semi-liquid vehicles, which offer similar exposure to a selection of funds and don’t ask their investors to lock up their capital for years, has threatened the market of investors who would typically go for funds-of-funds, namely the private wealth channel.”

Why some are optimistic about the Fund of Funds fundraising outlook for 2025

Despite these worrying trends, the prospects for FoF may not be as concerning as last year’s figures suggest. It is true that some individual investors will no longer need a FoF manager for access to private markets, but they may still require an intermediary to access the top private funds and hedge against risk through diversification.

An article from Russell Investments explains that the success of private funds has led to a drastic increase in their number, stating that, “from 2000 to 2023, the number of funds grew from 1,551 to more than 12,500.” Along with that increase, there is also the issue of quality, as there is a “significant dispersion between top and bottom-performing private markets strategies.”

Stating the clear fact that “manager selection is crucial to fund performance,” the article notes that “the annual internal rate of return (IRR) between top and bottom quartile private-markets funds has historically been as much as 25.24%.” Retail investors may be gaining access to private markets, but they cannot select funds with the skill of a seasoned FoF manager.

Beyond the small number of individual investors electing to research and select funds on their own, the retail sector relies heavily on private wealth advisors. These advisors have not built their reputations by advocating for unnecessary risk. They will urge their clients to stay away from all but the top-performing funds, which they may not have access to at their preferred investment amount.

With so many funds to sift through and such a gap between the best and worst funds, wealth managers would be wise to recommend a strategy where “a single solution can provide diverse exposure across regions and subsectors, still using skilled and highly vetted specialist managers within each assignment.”

If retail investors do try to invest with individual funds, they may find out the hard way that selecting the right manager is a difficult task, and the risk of ending up with the wrong fund is very real. When that happens, they are likely to look for a safer option, which FoF can provide.

As Oleg Gredil, Yan Liu, and Berk A. Sensoy noted in their paper Diversifying Private Equity, “investors

diversify more after encountering negative performance shocks.” Individual investors may not be able to diversify properly on their own because of both the work involved and the minimum investment amounts required, but FoF “create value through diversification even with average performance, especially for highly risk-averse investors.”

No matter where it is directed, private market investment looks to increase. According to Hamilton Lane’s Global Private Wealth Survey, 56% of advisors “plan to increase private market allocations” in 2025. That capital is going to go somewhere, whether to individual funds or to a diversified FoF strategy. Wealth advisors, if properly educated about the benefits of FoF, can uphold their own reputations by recommending a diverse and risk-averse strategy to their clients. And if not, the volatile nature of private markets will likely prove the value of such a strategy for the next investments those clients make.

Diversification, downside protection, and the fee crunch

Current retail investment products do not provide the broad diversification based on in-depth analysis that an experienced FoF manager can offer. But the expertise of a successful FoF manager comes with a cost in the form of fees.

As explained by Business Research Insights, “Investors can end up paying multiple layers of fees, including fees charged by the FoF manager and fees charged by the underlying funds. These fees can significantly reduce overall returns, particularly in a low-return environment. As a result, some investors may choose to avoid FoFs altogether.”

FoF managers would be quick to point out that while FoF may involve higher fees, it also offers greater downside protection. Vanguard concluded, “the value provided by an FoF has the potential to exceed these costs through improved diversification and risk-adjusted returns, superior manager access and selection, and capital call and operational simplicity.”

But when markets are not offering the returns investors desire, they may be unwilling to pay higher fees despite the potential benefits. Whether because of new retail products, an aversion to fees, or other reasons, the numbers show that investors have been moving away from FoF. The only way to win those investors back is to make a change in strategy.

How Fund of Funds managers will need to change their approach in order to compete

To attract capital in a difficult fundraising environment, FoF managers must overcome the sector’s reputation for being costly. While analyses have shown that FoF fees can be made up in performance over the long term, that will not solve the issue for an individual FoF manager. Each manager is not just promoting the sector as a whole – those managers are competing with each other for capital, and must differentiate in order to survive.

FoF managers will need to lean on their track records and demonstrate the value they bring. While diversification, downside risk, access, and simplicity may be enough to get an investor interested in FoF as opposed to other fund types, the way to set your fund apart from others in the sector is to be flexible on fees.

But the fees levied by FoF are not an accident – they are necessary because of the greater amount of work it takes to manage investments across a portfolio of funds, each of which has a series of investments that must be evaluated. FoF managers must deal with large amounts of data and have numerous GPs to communicate with, including those managing funds in the FoF portfolio and those engaged on a co-investment basis.

A FoF manager cannot simply lower fees without reducing costs elsewhere. In order to compete on fees, managers will need to find ways to be more efficient. This is where a fund administrator, such as JTC, can help.

What makes JTC’s approach to Fund of Funds different?

Outsourcing fund administration can improve efficiency for FoF, but only if it is done correctly. First of all, you need a team that understands the sector. JTC already supports the administration of the top 10% of FoFs globally, and we offer the same bespoke institutional-grade services to all our clients.

In addition to expert knowledge of the inner workings of FoF, we also work with private equity, real estate, venture capital, private credit, and many other asset classes all over the world. These asset classes make up the underlying portfolios of FoFs, and JTC has the tools to translate the data from disparate sectors for analysis by FoF managers.

Our industry-leading technology can also drive efficiencies in other areas, but the most important element we bring is our team. While many companies in the financial sector have staff turnover rates in the double digits, JTC’s staff turnover rate in 2024 was only 3.3%. That stability stems from a Shared Ownership model that encourages longevity. Instead of losing time and money hiring and training new people every year, you can rely on consistent service from JTC.

FoF is coming off a challenging period, and managers will need to rethink how they operate in order for the sector, and the individual funds that make up that sector, to remain viable. FoF managers must look to compete on fees, but doing so requires an understanding of how to become more efficient. With a fund administrator like JTC, you gain a partner who understands your needs, ready to develop a bespoke solution for your fund.