Funds of Funds & Secondaries: How These Private Fund Structures Work

A multi-manager fund of funds is a private fund that pools capital from its investors and commits it to several other private funds, each run by a different manager. The idea is to spread exposure across managers, strategies or time periods instead of relying on one team.

A secondary fund generally buys existing interests in private funds or private companies from current holders who want to sell before the original fund term ends. Because the underlying investments already exist, buyers can sometimes see more of what they are purchasing than in a brand-new fund. That is not the same as certainty about the outcome.

A co-investment program allows investors to put capital directly alongside a lead manager in a specific deal, often in addition to a fund commitment. Terms, fees and information rights vary, so the offering documents matter more than any general description.

Funds in these categories are typically offered under exemptions from registration, such as SEC Rule 506(b), which prohibits general solicitation, or Rule 506(c), which allows general solicitation if all purchasers are accredited investors and the issuer takes reasonable steps to verify their status.

Investors have traditionally used funds of funds to gain access to several managers through a single commitment, with the fund-of-funds manager handling selection, due diligence and ongoing monitoring. Some people value that delegation, while others prefer to choose managers themselves.

Because a fund of funds sits on top of underlying funds, fees may exist at more than one level: the fund of funds charges its own fees, and each underlying fund charges its own. This is often called layered fees. Readers are usually encouraged to read how fees, expenses and any carried interest are described in each set of offering documents.

Secondaries and co-investments have traditionally been approached as ways to adjust the timing or concentration of private fund exposure. Many investors review the term, capital call schedule, reporting, valuation approach and tax reporting, including whether a Schedule K-1 is issued, before deciding whether a structure fits their situation.

The right fund manager or independent professional may help you understand how a particular structure works, what sits underneath it, and how it compares with holding a single fund. They may also help you separate the marketing description from what the legal documents actually say.

A first conversation is usually informational. Expect questions about your goals, time horizon, need for access to your money, and whether you meet an accredited investor definition under SEC Rule 501(a). That definition includes certain income or net worth levels, holders in good standing of Series 7, 65 or 82 licenses, knowledgeable employees of the fund, spousal equivalents, registered investment advisers and exempt reporting advisers, and entities or family offices with over $5 million in investments or assets, among other categories.

Useful questions to ask include: What are all the fees at each layer? How are underlying managers selected and monitored? How are valuations determined? What are the lock-up and transfer terms? How concentrated is the portfolio? What conflicts of interest exist? How and when will I receive tax documents? Always consult your own licensed financial, legal and tax advisers.