Grove Street Advisors - Case Answers

Alternative Asset Classes (FINC5523)

Homework Case: Grove Street Advisors

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Tim Alexander Diemer

Student Number: 3379700

University of New South Wales, Business School

QUESTION 1.

Fund of funds

A fund of funds aggregates a number of smaller investments which are reinvested across different funds for diversification purposes (Rhodes-Kropf and Leamon 2010). In the private equity (PE) investment context, pooled capital is spread amongst various buyout funds and venture capital (VC) firms.

Fund of funds managers sit between the general partners (GPs) and limited partners (LPs) of a typical PE fund structure (Rhodes-Kropf and Leamon 2010). By design, they intermediate between parties and help resolve information asymmetry between inexperienced investors and sophisticated PE funds.

As stated by Rhodes-Kropf and Leamon (2010), fund of funds charge both fees and carry. Fees consist of either an annual flat fee regardless of total capital invested or are taken as a certain percentage of funds under management or committed. Managers may also charge carry on profits above a designated hurdle rate.

Reasons why funds of funds exist

There are several reasons funds of funds exist. Primarily, they allow institutional investors to outsource their PE investments and achieve significantly lower costs, given the range of challenges of managing these assets in-house (Rhodes-Kropf and Leamon 2010).

Fund of funds help bridge the capital gap by resolving issues of scaling up or down. They allow smaller investors to achieve diversification, by distributing capital jointly across various funds where they would otherwise face steep minimum stake requirements (Rhodes-Kropf and Leamon 2010).  

For larger investors unable to perform diligence and manage a wide range of VC investments, these managers facilitate VC investments in significant size, thereby driving down costs and assisting institutions in meeting asset allocation targets (Rhodes-Kropf and Leamon 2010).

Fund of funds also offer improved access to more exclusive VC firms through their industry expertise and relationships. Kaplan and Schoar (2005) state that funds which perform excellently remained successful over long periods, hence investing with top-tier firms is paramount.

Additionally, fund of funds attempt to overcome timing concerns and aim to ensure their investors gain access to the limited number of funds a top-performing VC firm may raise in any given year (Rhodes-Kropf and Leamon 2010).

QUESTION 2.

GSA’s investment strategies and allocation practices

Grove Street Advisors (GSA) seeks out ‘top-tier established funds and emerging managers’ (Rhodes-Kropf and Leamon 2010, p.10). Across buyout managers, the fund of funds selects smaller teams as limited size allows emerging managers to capture higher returns than more mature funds.

In the VC sector, GSA invests with the top 20 to 30 firms. This requires early identification to ensure they contribute to these VC firm’s initial fundraising rounds so to receive a meaningful allocation in latter funds (Rhodes-Kropf and Leamon 2010).

As opposed to sourcing these through public relationships or placement agents, GSA generates more than 85% of its relationships proactively and performs extensive due diligence on its investments (Kropf and Leamon 2010). After an initial evaluation, the fund of funds tables a ‘soft circle’ commitment to the manager while performing a more thorough examination, which is then followed by a ‘hard circle’ commitment amount (Kropf and Leamon 2010, p.10).

Furthermore, GSA remains involved with the GP throughout the investment funds lifecycle, performing internal monitoring activities through their investment team and undertaking quarterly tracking as a function of their operations group. GSA partners also support their fund portfolio by sitting on advisory boards, where they assist with both operational and strategic issues and occasionally provide deal flow (Kropf and Leamon 2010).

How GSA adds value to client investments

GSA takes a highly-customised approach and structures its funds respective to clients’ investment needs, with asset allocations determined across stage, geography, sector and year (Rhodes-Kropf and Leamon 2010). For smaller clients GSA’s mandate can consist of their entire PE program, while larger institutions may only outsource a specific area.

Additionally, the fund of funds is willing to transfer their relationship with a PE firm to their client over a period of time. GSA helps foster a relationship between the two parties, allowing clients to invest alongside them by their second fund and intending for these institutions to invest directly with the PE manager by the third fund raising (Rhodes-Kropf and Leamon 2010).