Funds of Venture Capital Funds Have Edge Over Buyout Peers

Funds of funds invested in venture capital tend to perform better against their direct investing peers than buyout fund of funds, according to a paper from the National Bureau of Economic Research.

Buyout funds of funds saw “significantly lower” returns than their direct investing peers, while venture-capital funds of funds performed “roughly on par” with their direct investing counterparts even after the additional fees, according to thepaperthat was authored by researchers Robert Harris, Tim Jenkinson, Steven Kaplan and Ruediger Stucke and released this week by the NBER.

Established venture-capital fund of funds are able to provide their investors exposure to top-performing venture capital managers, which typically limit the access of new investors to their funds. That helps them to overcome the additional layer of fees that managers of funds of funds charge to deliver returns. And while venture capital investing tends to be riskier, venture-capital funds of funds tend to mitigate that risk due to their diversification.

“Given the highly-dispersed nature of direct fund returns in venture, venture capital funds of funds create more risk reduction through diversification than is the case for buyouts,” the authors wrote in the report.

Buyout fund of funds underperform their direct investing peers because of their additional funds-of-funds fees, suggesting that buyout funds of funds are “unable to choose direct funds that will outperform,” according to the report. The authors noted that their analysis also suggests that the diversification in venture capital funds of funds creates more risk reduction than buyout funds of funds.