Fund-of-funds (FoFs) structures offer investors diversified exposure to private markets, but they also introduce complexity in performance measurement. For professionals across fund administration, legal, banking, and placement advisory roles, understanding how layered fees and aggregated returns interact is essential, not just for reporting accuracy, but for strategic decision-making.
This article breaks down the mechanics of FoF performance metrics, clarifies common misconceptions, and offers practical insights into how administrators and surrounding professionals can better interpret and communicate results.
The Fee Stack: Where Performance Gets Diluted
At the heart of FoF performance complexity is the fee layering effect. Investors in a FoF pay:
Management and incentive fees at the FoF level, and
Management and incentive fees at the underlying fund level.
This double layer of fees can significantly dilute net returns, especially when underlying funds perform well and trigger carry. For example, a FoF reporting a 12% gross IRR might show only 7–8% net IRR after all fees are accounted for. This dilution can sometimes be misunderstood or under-communicated in investor materials.
Key takeaway: Fee transparency is not just a regulatory concern, it’s a strategic imperative. Administrators should ensure that fee disclosures are clearly separated by layer and that net-to-investor returns are contextualized accordingly.
Aggregated Returns: Apples, Oranges, and Weighted Averages
FoFs typically invest in a mix of fund vintages, strategies, and geographies. Aggregating performance across these dimensions introduces challenges:
Vintage dispersion: Older funds may be fully realized, while newer ones are still in J-curve territory.
Strategy heterogeneity: Buyout, venture, credit, and secondaries behave differently across cycles.
Currency and timing effects: FX and capital call timing can skew IRRs if not normalized.
Administrators often use weighted average IRRs or TVPIs, but these can mask underlying volatility. A FoF with a 1.5x TVPI might include funds ranging from 0.9x to 2.2x. Without proper stratification, performance reporting can mislead stakeholders.
Best practice: Segment performance by vintage and strategy, and present both weighted and unweighted metrics. Include dispersion ranges to highlight variability.
Benchmarking: The Mirage of Peer Comparisons
Benchmarking FoFs is notoriously difficult. Unlike direct funds, FoFs don’t have standardized peer sets. Public benchmarks (e.g., Cambridge Associates, Burgiss) often lack granularity at the FoF level, and custom benchmarks require access to underlying fund data that may not be available.
Alternative approach: Use internal benchmarks based on historical FoF vintages or construct synthetic benchmarks using weighted averages of underlying fund strategies. While imperfect, these offer more relevant context than broad market indices.
Final Thoughts
Fund-of-funds performance metrics are more than just numbers, they’re layered narratives. Understanding how fees dilute returns, how aggregation can obscure dispersion, and how technology can help clarify complexity is essential for anyone working around private capital.