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The latest blow

Carlyle’s acquisition of Metropolitan Real Estate raises more doubts about the ability of real estate fund of funds managers to survive as a standalone operation.

In the past year, at least three real estate fund of funds platforms have been absorbed into larger companies or shut down entirely.

The latest example is Metropolitan Real Estate Equity Management, which The Carlyle Group plans to acquire and incorporate into its larger fund of funds business, as was announced earlier this week. The news of the takeover came just a month after Cohen & Steers pulled the plug on its real estate fund of funds platform and less than a year after LGT Capital bought Clerestory Capital Advisors.

With $2.7 billion in assets and 40 people in five offices, 10-year-old Metropolitan is larger and more established than many of its competitors. But the firm is said to have lacked the resources to expand beyond its core client base of smaller and mid-sized investors. It needed the backing of a large firm like Carlyle – with deep pockets and an equally deep network of large institutional clients, not to mention its expanded bench of IR professionals – to take its business to the next level.

PERE understands that Carlyle is not the only company looking to buy a real estate fund of funds platform as a way to build out their own real estate or alternatives offerings. As such, the reshuffling of multi-managers is likely far from over.

Of course, traditional managers have consolidated in the past year as well. But with fund of funds managers representing a far smaller universe, takeovers and casualties have affected a much larger segment of the market.

Why has the fund of funds market been in a state of flux? Generally speaking, fund of fund managers have faced greater challenges raising capital than traditional fund sponsors. At the heart of the issue is the model, where limited partners are subject to a double-promote structure on their investments. Because such a structure lowers net returns, many investors view these vehicles as relative underperformers – a major reason why funds of funds regularly are criticized by investors and consultants alike – even during more robust fundraising years.

In response, many firms, including Metropolitan, have shifted from investing solely in funds and expanded into other strategies, such as co-investments, secondary transactions and joint ventures. Cohen & Steers even adopted such an approach at the start of its multi-manager platform, investing about half of its debut real estate fund of funds in co-investments and direct joint ventures and the remainder in operator-focused funds. But such efforts evidently didn’t improve investor enthusiasm for the vehicle type.

Where real estate fund of funds have been most valuable is with smaller investors, namely foundations, endowments and high-net-worth individuals, that rely on funds of funds to access real estate opportunities that otherwise would not be available to them. Multi-managers also have been active in overseeing mandates such as emerging manager programs for institutional investors that lack the time and resources to manage such programs on their own.

But because smaller investors have smaller checkbooks, multi-managers generally raise less capital than their traditional fund manager counterparts, even though running a fund of funds business is no less capital-intensive.  And if a firm has less capital to work with, its long-term viability as an independent company can get called into question.

The debate about the viability of the fund of funds model is not new. As detailed, there are pros and cons and these fluctuate in importance depending on who you speak to, and sometimes when. Perhaps a bigger question stemming from Metropolitan’s news, and Clerestory’s before it for that matter, is exactly what value do bigger shops like Carlyle see in this segment of the investment universe.