Smaller Venture Drive Interest in FoFs –

When Pomona Capital closed its fourth fund-of-funds (FoF) this summer, capping it at $250 million, Michael Granoff, Pomona’s CEO, said that due to strong demand from limited partners, the New York-based firm could have raised at least $300 million … or more.

The firm’s previous FoF fund raised $135 million and closed in 2000. Pomona did not disclose the names of its investors. But LPs in past Pomona FoF and secondary funds includes BancBoston Investments, Blackstone Management Corp., Chase Capital Partners, Siguler Guff & Co. and South Ferry, according to Thomson Venture Economics (publisher of VCJ).

“We’re at a time right now in the private equity world where access to top-tier funds is limited,” says Granoff, in explaining why Pomona’s latest FoF had so much interest from LPs. “There’s a limit to how much capital LPs can deploy in the highest quality funds.”

So, naturally, he says, as many VC funds are raising smaller funds than they did a few years, more and more LPs are eyeing the FoF market as a place to invest.

Some limiteds are scrambling just to keep up with their stated allocations. Institutions that didn’t previously invest in private equity have become converts to the asset class are on looking at FoFs and other funds to invest in. Pension systems in New York City, Mississippi, New Jersey and New Mexico, for instance, are just a few of the new institutional investors that jumped into additional asset class.

Scott Potter, managing partner of newly launched San Francisco Equity Partners, says the perceived growth of FoFs mirrors what’s going on in other asset classes.

“There are a lot of funds out there and investors are looking for a place to park their money,” Potter says.

Indeed, Some FoFs are having no problem raising new vehicles in 2005.

For example, Adams Street Partners has raised the largest FoF to date in 2005. The firm has raised more than $1.3 billion for its FoF.

Goldman Sachs Asset Management, which has been dealing with a management shakeup of its private equity group, exceeded its target threefold on its private equity FoF, which closed in May. The firm raised $1.5 billion for GS Private Equity Partners 2004, the firm’s seventh FoF.

Meanwhile, Morgan Stanley Alternative Investment Partners capped off its second private equity FoF-Morgan Stanley AIP Global Diversified Fund LP. The firm, which sold off its direct-investing private equity arm last year, corralled $500 million for its FoF, exceeding its $310 million, 2002 predecessor fund, and topping its $350 million target for the current vehicle.

Morgan Stanley’s FoF has already made a dozen commitments and has more than three-fourths of its capital remaining. Morgan Stanley AIP co-head Corey Pulfrey says that the fund will focus on the less efficient spaces of the private equity market, with about 60% of the capital going toward buyouts, while the balance is roughly evenly split between venture capital and special situations.

“There’s been an overall uptick in fund-raising,” Pulfrey says. “People are recognizing that private equity is an interesting opportunity and they’re getting back into the market.”

Pulfrey is not alone. Knightsbridge Advisers Inc. also closed a FoF this year, raising $500 million from institutional investors. The FoF, KVC VI, invests in early stage venture funds. Managing Principal Joel Romines says the firm received “strong investor interest” during the fund-raising. “Maintaining our size caused us to turn away substantial investor demand,” Romines says.

But despite the enthusiasm from Romines, Pulfrey and other FoF managers, the FoF market is on pace to be smaller in 2005 in comparison to recent years.

For the first six months of the year, only some two dozen FoFs have raised about $6 billion, according to research by Thomson Venture Economics and the National Venture Capital Association. At that pace, 2005 FoF fund-raising activity will fall short of last year’s activity, when 86 funds raised nearly $17 billion. The high watermark for FoFs was 2000, when 125 funds raised more than $30 billion from investors.

Potter of San Francisco Private Equity says that the numbers for FoF should pick up in during the rest of 2005, because of all the benefits that FoFs provide. For instance, investors often choose FoFs-a fund partnership organized to invest in other funds-because they provide LPs with added diversification and the ability to invest smaller amounts into a variety of funds.

Diversification is a major part of the overall strategy for Invesco Private Capital, which has raised nearly $500 million for its fourth FoF. Among its LPs are public funds, endowments and foundations, corporate pension plans and high-net-worth individuals. Invesco Managing Partner Parag Saxena points out that the appeal of the firm’s FoF is that investment opportunities can be limiting if, as an investor, has less than $1 billion to invest.

“Many name-brand venture firms are raising smaller funds in 2005, so LPs could find that they’re locked out of certain funds, they have too much competition, or they are asked to invest a smaller amount than they hoped,” Potter says. “That opens the doors for fund-of-funds to have a bonanza year for fund-raising. I expect lots more fund-of-funds to raise money this year.”