Although private equity and venture capital markets have become more accessible to a wider range of investors, hurdles remain for qualified individual investors. They often lack access to quality PE and VC managers and typically don’t have the resources to perform the due diligence necessary to assess the potential of the numerous PE and VC funds in the market, particularly seed and early-stage venture capital funds.
The reality is, unless you’re operating in this space every day, navigating the PE/VC landscape is difficult. Fairway Capital Management’s ’40 Act registered investment vehicle seeks to solve these challenges.
In this blog post, Fairway Founding Partner Kevin Callahan peels back the layers of Fairway’s Private Equity & Venture Capital Opportunities Fund to show how this registered fund can help provide solutions to some of the challenges that qualified individual investors often face.
What’s the objective of Fairway’s Private Equity & Venture Capital Opportunities Fund and how does this influence portfolio construction?
Kevin: Our overall goal is to provide a core private equity and venture capital offering delivered in a structure that is more flexible than a traditional PE or VC fund structure. Further, we want our fund to have the potential to deliver higher returns than other similar offerings. Thoughtful portfolio construction is key to our ability to help deliver on these objectives.
In terms of the overall structure, we believe the ’40 Act tender offer fund structure addresses many of the frustrations PE and VC investors have lived with over the years. Some of the highlights of the structure are as follows:
- Periodic openings that allow for new investment and limited redemptions quarterly
- Evergreen fund that provides immediate and continuous exposure to high-quality PE/VC
- Diversified PE and VC exposure in a single allocation
While we are certainly not the first to offer private equity exposure in a ’40 Act fund structure, we wanted to offer a portfolio that has the potential to deliver higher returns than other similar offerings. Both buyout and venture capital investments have historically delivered attractive returns relative to public benchmarks. Having said that, they don’t always generate attractive returns in lock step (in some time periods, venture capital returns are more attractive than buyout returns and in other time periods it is the opposite). So, for a core PE/VC offering, we think it is important to have a balanced portfolio, with meaningful exposure to both buyouts and venture capital. With all of this in mind, we set a target allocation of 40% venture capital, 40% buyout, 15% special situations (primarily private credit) and 5% liquid.
The most notable difference in our portfolio relative to other ’40 Act funds is the 40% allocation to venture capital, which is much larger than most registered funds. If you look at long-term investment performance, the real standout is venture capital, assuming you can access high-quality funds. We are very fortunate that our investment team members have been investing in both buyout funds and venture capital funds for decades and have relationships with many leading PE and VC managers. This access to high-quality venture capital managers is extremely important and we think our venture capital exposure will be a meaningful driver of investment returns going forward. We believe this access to highly sought-after funds is evident in our portfolio, so we are very pleased with the quality of the initial investments in the fund.
"While we are certainly not the first to offer private equity exposure in a ’40 Act fund structure, we wanted to offer a portfolio that has the potential to deliver higher returns than other similar offerings."
What about various types of investments within PE and VC?
Kevin: We think it is important to have a good mix of investment types in the portfolio as well. Our target ranges are as follows:
- Primary Funds: 40–50%
- Secondary Investments: 30–50%
- Direct Investments: 10–30%
We do think it is important to have the flexibility of the ranges and not force these allocations. For example, most registered vehicles begin with a significant allocation to secondaries in order to gain immediate market exposure. Given the environment when we launched (1Q 2022), we made the decision to initially invest more in primary investments and less in secondaries. Having said that, we expect to see more attractive secondary opportunities as we look ahead to 2023.
With a portfolio of private equity and venture capital, how do you plan for liquidity?
Kevin: The short answer is we will always plan to have 5% of the portfolio in liquid assets, consistent with our fund documents which target having 5% available for withdrawals each quarter. The longer answer is more complicated and, again, thoughtful portfolio construction is important.
First, there is no doubt that many of the underlying investments in the fund are highly illiquid and should always be considered long-term in nature. Illiquidity in venture capital and private equity investments is expected. Having said that, there are many differences when it comes to the liquidity and duration profile of the various investments in the portfolio. For example, venture capital primary seed fund investments will typically have a longer life than later-stage or growth fund investments. Likewise, secondary investments will typically have a shorter duration than primary funds. All of these factors are considered when managing the portfolio. Managing the portfolio’s overall duration and liquidity is the main reason we like having a 15% allocation to private credit. We invested with a very experienced private credit manager that has a great long-term track record of managing portfolios that deliver attractive overall returns with a nice yield and, in general, have a very different liquidity/duration profile than the other holdings in the portfolio. One way to look at it is that we have somewhat of a “barbell” approach when it comes to liquidity. At one end is the highly illiquid, long-duration venture capital seed funds (which should generate higher returns). At the other end is 5% held in cash as well as an allocation to private credit, with many other PE/VC investments with a variety of liquidity profiles in between.
What role does the Fund’s size play in portfolio construction and performance?
Kevin: At Fairway, strategy drives fundraising, not the other way around. As noted, we think it is important to have a meaningful allocation to venture capital in the portfolio with our 40% target. This target will ultimately drive the capacity for our portfolio since venture capital as an asset class is not infinitely scalable. Further, our venture portfolios have always had a significant allocation to seed and early-stage funds and these funds tend to be smaller in size. Since we are just getting started with this ’40 Act Fund, capacity is not a problem at all. We have no problem keeping our focus on only high-quality funds and companies while maintaining our desired portfolio exposure targets and won’t for a long time. However, fund size is something we are always cognizant of. Larger amounts of capital inevitably lead investors to expand their funnel to include larger underlying funds, more growth equity funds, etc., which we think are unlikely to deliver returns as strong as the best seed and early-stage funds going forward.
For information about the structure of Fairway’s Private Equity & Venture Capital Opportunities Fund, click here. To learn more about Fairway’s approach to PE/VC investing, check out some of the Insights published by our team.
Investors should carefully consider the investment objectives, risks, and charges and expenses of the Fund before investing. This and other important information about the Fund is contained in the Prospectus, which can be obtained at www.fairwaycapm.com. The Prospectus should be read carefully before investing. The Fund is distributed by Ultimus Fund Distributors, LLC. There is no affiliation between Ultimus Fund Distributors, LLC and Fairway Capital Management, LLC.
Important Risk Information
The Fund has been organized as a non-diversified, closed-end management investment company and designed primarily for long-term investors. Shares are speculative and illiquid securities involving substantial risk of loss. Investment in the Fund is not suitable for all investors. An investor should not invest in the Fund if the investor needs a liquid investment. Shares are not listed on any securities exchange and it is not anticipated that a secondary market for shares will develop. Shares are subject to substantial restrictions on transferability and resale and may not be transferred or resold except as permitted under the Agreement and Declaration of Trust. Although the Fund may offer to repurchase Shares from time to time, Shares will not be redeemable at a Shareholder’s option nor will they be exchangeable for shares of any other fund. As a result, an investor may not be able to sell or otherwise liquidate his or her Shares. Shares are appropriate only for those investors who can tolerate a high degree of risk and do not require a liquid investment and for whom an investment in the Fund does not constitute a complete investment program.
The Fund is a "non-diversified" management investment company. Thus, there are no percentage limitations imposed by the 1940 Act on the Fund's assets that may be invested, directly or indirectly, in the securities of any one issuer. Consequently, if one or more Fund Investments are allocated a relatively large percentage of the Fund's assets, losses suffered by such Fund Investments could result in a higher reduction in the Fund's capital than if such capital had been more proportionately allocated among a larger number of investments.
The Fund Investments will include direct and indirect investments in various companies, ventures and businesses ("Portfolio Companies"). This may include Portfolio Companies in the early phases of development, which can be highly risky due to the lack of a significant operating history, fully developed product lines, experienced management, or a proven market for their products. The Fund Investments may also include Portfolio Companies that are in a state of distress, or which have a poor record, and which are undergoing restructuring or changes in management, and there can be no assurances that such restructuring or changes will be successful. The management of such Portfolio Companies may depend on one or two key individuals, and the loss of the services of any of such individuals may adversely affect the performance of such Portfolio Companies. Some or all of the Portfolio Fund Managers (subject to applicable law) and the Fund may use options, swaps, futures contracts, forward agreements and other derivatives contracts. Transactions in derivative instruments present risks arising from the use of leverage (which increases the magnitude of losses), volatility, the possibility of default by a counterparty, and illiquidity. Use of derivative instruments for hedging or speculative purposes by the Fund or the Portfolio Fund Managers could present significant risks, including the risk of losses in excess of the amounts invested.
As an indirect investor in the Portfolio Funds managed by Portfolio Fund Managers that are not registered as investment advisers, the Fund will not have the benefit of certain of the protections of the Advisers Act. The securities of the Portfolio Funds in which the Fund invests or plans to invest will generally be illiquid. The Adviser does not control the investments or operations of the Portfolio Funds. A Portfolio Fund Manager may employ investment strategies that differ from its past practices and are not fully disclosed to the Adviser and that involve risks that are not anticipated by the Adviser.As an indirect investor in the Portfolio Funds managed by Portfolio Fund Managers that are not registered as investment advisers, the Fund will not have the benefit of certain of the protections of the Advisers Act. The securities of the Portfolio Funds in which the Fund invests or plans to invest will generally be illiquid. The Adviser does not control the investments or operations of the Portfolio Funds. A Portfolio Fund Manager may employ investment strategies that differ from its past practices and are not fully disclosed to the Adviser and that involve risks that are not anticipated by the Adviser.
In view of the risks noted above, the Fund should be considered a speculative investment and prospective investors should invest in the Fund only if they can sustain a complete loss of their investment. No guarantee or representation is made that the investment strategy of the Fund will be successful, that the various Portfolio Funds or Co-Investments selected will produce positive returns, or that the Fund will achieve its investment objective. Please see the Prospectus for additional risk information.