Wealth & Finance International - Fund Awards 2015

www.wealthandfinance-intl.com 7 fund of funds, institutions without in-house private equity real estate and infrastructure expertise and experience can rely on professionals to perform the kind of investment research, monitoring and due diligence that is necessary to avoid choosing the wrong manager, avoiding fraud and other potential costly mistakes. Manager selection is certainly the foremost area of expertise of a pro- fessional private equity real estate and infrastructure fund of funds. A well-structured and executed due diligence process, financial and opera- tional understanding and access to the best private equity real estate and infrastructure funds in the market are the core competences of a traditional fund of funds. Most of the experienced fund of funds around the globe follow similar principles in the due diligence process and strive for the same goal and to select managers that generate best in class returns for their investors in their respective market segment. Although diligent fund selection should certainly limit the downside of a private eq- uity real estate and infrastructure portfolio, most investors would rather pick a fund of funds for the upside potential through manager selection. This is certainly demonstrated by performance data of fund of funds managed by Deutsche Finance. Wider Access to Fund Managers – Institutional investors without or with limited private equity real estate and infrastructure fund expertise in cer- tain markets or at all may make more conservative choices in large and well known funds or will avoid a market. In contrast, experienced fund of funds managers knowledgeably navigate a wide universe of potential managers and sometimes concentrate on more focused strategies to identify those that may offer a unique competitive advantage or more favourable investment terms. Portfolio Diversification to Reduce Risk - Many investors lack the necessary size for appropriate diversification, and only fund of funds may allow these investors to reduce manager or market specific risk in selected segments. Portfolio Diversification to Enhance Performance - Seeking portfolio diversification for the purpose of enhancing returns may seem to be a contradiction for many investors, given that the principal reason for port- folio diversification is to reduce risk. But it is likely that the performance of a single fund is lower than the performance of a pool of funds. For an investor with a given return target, it is wise to diversify the portfolio to increase the probability that this return is actually achieved. Additionally the combination of primary funds with secondaries and co-investments in an indirect portfolio is for many reasons not easily executed by a typical investor. It can enhance the performance of a portfolio significantly when it comes to peak equity exposure. But it also requires a lot of experience how to combine a portfolio, to organize access to secondaries and co-investments and it requires resources to conduct a proper due diligence on the different strategies and to make quick decisions. Performance Incentive Alignment – Fund of fund managers often invest alongside their investors, which provides incentive to generate attractive returns that benefit managers and clients alike. Beside the arguments discussed above there are more areas of expertise of a fund of funds manager which are often not on the screen of an investor but even as important: Favourable Investment Terms – Intensively negotiating fund and in- vestment terms is an important element of value creation that is often not recognised by investors. Funds of funds are able to leverage the negotiating power of a large pool of comingled assets to arrange for more favourable investor terms and rights with underlying managers. For ex- ample, managers may agree to fewer restrictions on redeeming capital, lower fees, more alignment of the manager, more performance related share of fees and greater transparency. Fund of funds negotiate with private equity real estate and infrastructure funds to ensure that terms are in line with industry standards. Fund of funds are important to ensure proper downside protection and alignment of interest between limited partners and general partners. Many GPs are even willing to accept more LP-friendly terms to get a renowned in- vestor, which should ultimately attract further investors. We at Deutsche Finance always negotiate hard to get a GP fully aligned to our investors and to make sure that the GP does not earn real money before our investors do. Reporting – Proper reporting is even important for most investors. Gaining the know-how, setting up the necessary software and staffing a qualified team means significant costs that are inappropriate when an institution is invested in just a handful of private equity real estate and infrastructure funds. Professional fund of funds managers that have to deal with more than a hundred fund investments in their various vehi- cles, by contrast, have the necessary economies of scale to justify such expenses. Thus, established fund of funds managers can provide their investors with a state-of-the-art reporting that reduces the administrative burden for their clients. Access to Co-investments and Secondaries – For the private equity real estate and infrastructure industry network to include secondaries and co-investments in a private equity real estate portfolio, an extensive GP network is necessary to provide for the necessary deal flow. Moreover, while private equity real estate funds are generally not selective when it comes to accepting money for fund commitments, access to second- aries and co- investments is not always the norm. A number of highly successful fundraisings for secondary funds in recent years, and the increased appetite for secondary transactions displayed by investors, often lead to auctions. What are a fund of funds advantages in such competitive situations? GPs often favour buyers with a solid primary business. After all, private equity real estate funds would like to keep or grow their investor base and would rather give transfer consent to poten- tial long-term investors. For them, the ideal secondary investor will likely re-up to the next fund. Pure secondary players start to give more notice to these facts, reserving a part of their fund for primary commitments, in order to help them in obtaining transfer consents when purchasing secondary portfolios. When looking at co-investments, why would a GP share the best investment opportunities and give up the performance fee on these deals? There are two reasons why a GP may do so in the case of a fund of funds. Firstly, fund of funds managers are often large investors and thus have the necessary leverage to secure co-investment rights. Secondly, fund of funds can add value to the GP through their exten- sive industry network. After all, private equity real estate is a people’s business and putting the right people together can help GPs to solve some of their issues. After investing in more than 200 investment strategies globally in their career the Deutsche Finance team earned a lot of reputation in executing secondaries and co-investment opportunities diligently and quickly. So we have a permanent access to interesting opportunities in this market. We also organise other equity partners if an opportunity is too big for us.

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