A THOROUGH UNDERSTANDING OF PRIVATE EQUITY

RETOUR SOMMAIRE

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - 2010

INDUSTRY OVERVIEW

• Fund of funds A private equity fund of funds invests in a selection of other private equity funds, instead of directly acquiring companies. Fund of funds have historically served an important function in the private equity industry: > For investors, they provide instant access to a diversified portfolio of investments with- out the need for a complex and costly private equity investment program, since the fund of funds invests in private equity funds which are focused on various geographic and industry sectors, as well as in private equity funds at various stages of their life cycle. Fund of funds are often an entry point into private equity; New investors in pri- vate equity often gain access to the industry through fund of funds, before moving on to invest a larger proportion of their allocation into direct investments, as they become more knowledgeable and experienced in this asset class. • Primary funds Primary fund investing refers to investments made by an investor in a private equity fund during initial and subsequent closings, i.e. when capital commitments are being solicited. By making a primary fund investment, an investor participates in the fund from its inception and can realise the full benefit of distributions and gains as portfolio invest- ments are made and realised. In addition, investors who make primary fund investments may have an opportunity to negotiate terms and conditions with the promoter of the fund, as the fund is being established. • Secondary funds Secondary fund investing refers to the purchase of an existing portfolio of private equity fund investments, after some or all of the capital commitments of the LPs have already been called and invested. The secondary market provide an additional way for investors to get into private equity by buying exposure to private equity funds either directly or through secondary fund of funds. It also enables existing LPs, who can no longer honour commitments, to transfer their shares and exit a private equity fund before the end of the fund’s lifecycle, via a privately negotiated “secondary” transaction with the GP’s consent. One of the main advantages of the secondary market for buyers is that they can avoid the J-curve effect and have the opportunity to achieve a higher Internal Rate of Return (IRR). Indeed, in a secondary transaction, the limited partnerships are already a few years old and buyers can expect mostly distributions and very few drawdown calls. Thus, the money invested is not tied up for a decade but just for a few years. Buyers also face little complex- ity in planning their liquidity needs for capital calls, and mostly only face the uncertainty of unknown distributions 7 . In addition, by investing in the secondary market, an LP can access funds of older vintages 8 , providing increased diversification. > For fund managers, they act as a vital source of capital, especially for those without a long track record and those focusing on niche industries and regions. P rimary funds versus secondary funds

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7 Source: Euromoney Books, “Exposed to the J-Curve: Understanding and managing private equity fund investments” by Ulrich Grabenwarter and TomWeidig, 2005 8 The vintage year represents the year in which the fund made its first investment.

A thorough understanding of PE | page 19