A Global Asset Class
Another reason to consider funds of funds is the gradual extension of PE investing beyond the shores of the United States. In Europe, for example—the largest economy in the world—PE opportunities are growing rapidly. At this writing, the opportunities are mainly in buyouts, resulting from the high level of cross-border merger and acquisition activity. Unlike in the United States, where larger buyouts represent 80 percent of the market, in Europe large and smaller buyouts are about equal in number. Buyouts represent about half the percentage of GDP in Europe as they represent in the United States,8 so there is plenty of room for the market to grow. As is the case in the United States, returns are the highest with small and mid-cap funds, but these are the most difficult funds to access.
Asia offers an increasingly wide range of opportunities in private equity. From 2000 until the end of 2010, Asian PE increased fourfold to levels competitive with the United States and Europe. Moreover, it weathered the 1997 meltdown, the 2000 tech bubble, and the 2007 credit crisis better than other parts of the world. However, Asian venture and buyout funds are very difficult for families to identify, vet, and monitor.
Israel has traditionally been a venture capital market, but there is an emerging later stage and buyout component. Key drivers of PE in Israel include outsized national expenditures on research and development and one of the most highly educated populations in the world. Again, however, access to funds is very difficult.
True as it is that PE has become an increasingly global asset class, it must also be said the returns outside the United States have not been strong over longer time horizons. European venture capital returns, for example, have actually been negative over the past 20 years. Also, given the current uncertain state of the European community, it's difficult to predict how well PE funds will do in the intermediate-term future. Europe's disarray will certainly create opportunities, but it will also create many unexpected speed bumps for PE-backed businesses.
If you are planning to encourage your clients to build non-U.S. diversification into their PE portfolios, you will need to have in mind a thesis for how they will make enough money to justify the long lockup.