The Background

Experienced investment practitioners and prominent books on investment strategies teach us the same: diversification is the magic word for long-term investment gain—the "secret formula" for realizing more balanced returns while dispersing your risks when investing in any kind of asset class with any long-term view logic. One can follow this logic in public markets by building a personal portfolio through market-indexed funds, ETFs, a combination of real estate exposure, equity, debt, derivative asset classes, or even gold and crypto. However, achieving great diversification of risk and return requires sufficient funds on one side and access to a significant amount of data and know-how on the other.

Even if one believes that diversified asset allocations are safer than single bets, recent market developments demonstrate that although bonds and equities typically move in opposite directions due to their differing sensitivity to interest rates and economic conditions, they can also move in the same direction during periods of significant market intervention or economic stress. For example, during the 2008 financial crisis and the COVID-19 pandemic, both bonds and equities initially declined due to the shock and uncertainty but then rallied significantly as central banks and governments worldwide introduced massive stimulus measures.

Ray Dalio, the founder of Bridgewater Associates, refers to diversification as the "Holy Grail of Investing." Dalio emphasizes that the key to successful investing lies in constructing a well-diversified portfolio that balances risk and reward across a wide range of uncorrelated asset classes. The idea is rooted in the concept that by holding a diverse array of uncorrelated assets, an investor can significantly reduce overall portfolio risk while maintaining or even enhancing expected returns. According to Dalio, this strategy works because the likelihood of all asset classes performing poorly simultaneously is low. When one asset class is underperforming, others are likely to be doing well, thereby stabilizing the portfolio’s overall performance.

According to the historical data referenced in The Holy Grail of Investing by Tony Robbins and Christopher Zook, alternative investment funds, which include private equity, private debt, real estate, renewables, have significantly outperformed public markets over the last 5 to 35 years.

Further data suggests that alternative investments and other non-traditional assets have outperformed public markets by an average of 5% to 7% annually during these periods. This outperformance can be attributed to several factors, including the ability of alternative investment managers (known as general partners, or GPs) to access unique opportunities, utilize leverage, and benefit from active management strategies that are less constrained by market indices or regulatory requirements typically impacting public markets.

The Logic

Now, imagine that with a single investment, a professional investor could achieve that diversification—a five-dimensional diversification:

1. By the types of funds you own (private equity, private debt, private real estate, private renewables…)
2. By the unique industry skillset and experience (healthcare, FMCG, financial services, technology…) of the funds in which you own a stake
3. By geographical focus
4. By the vintages of funds (past, present, and future) managed by the fund manager
5. By the portfolio of companies or assets within each individual fund managed by the fund manager

This is the essence of investing in GP stakes. General Partners (GPs) manage alternative investment funds for professional investors and earn their income from two primary sources:

• Highly predictable locked-in management fees: Typically, 2% of AUM (Assets Under Management) generates an average net income margin of 45%-50% for the best-skilled GPs across individual funds.
• Carried Interest: Typically 20%, this is the GP's share of the profits for each fund's performance, where 3x money-over-money within the fund term is the norm for a GP operating in line with best practices.

For the best-performing GPs, the market’s fundamentals are robust, and the AUM recycling rate is high if the track record justifies the attractive proposition.

GP stakes are an asset class generally closed to the majority of retail investors at the initial primary market. This asset class has shown incredibly strong growth, starting in the US about a decade ago and now transitioning to Europe. It is an asset class that is only beginning to see a consolidation pattern—an asset class where investment opportunities are rare and far between. Within this asset class, truly asymmetrical risk/return opportunities (very limited downside but high upside) can be found with those professional GP firms that manage multiple uncorrelated asset classes (funds) that themselves are also diversified in terms of individual investment bets and vintage.

‍

The Opportunity of investing in GPs in SEE

The only such asset in the wider Southeast Europe (SEE) is ALFI Funds. Founded only six years ago, it is already the largest private multi-asset GP in the SEE region, managing 8 funds across 5 uncorrelated risk/return asset classes with EUR 550 million AUM. ALFI Funds is currently raising 4 new funds across 4 different asset classes, targeting a successful close of EUR 1,1 billion AUM by the end of 2025. Once you look “under the hood,” it becomes clear that this is the ultimate asymmetrical risk/return opportunity in the wider region. Essentially, I’m describing a GP asset class “Series A” opportunity.

This is an opportunity for a seasonal LP with a synergistic LP network, which could find comfort in the following fundamentally logical investment thesis:
‍

• SEE region macro vs. Core EU
  • Average GDP growth (2020-2023): SEE 2.85% p.a. (vs. 0.95% for Core EU)
  • Expected GDP growth (2024-2028): SEE 3.15% p.a. (vs. 1.55% for Core EU)
  • Government Debt/GDP in 2023: 54% (SEE) vs. 80% (Core EU) vs. 83% (EU)
  • Frontier market to Emerging market transition case (e.g., Romania) to be followed by other SEE markets
    ‍
• AUM growth trends in the SEE region
  • Public data sources indicate a compound annual growth rate (CAGR) of around 6% from 2017 to 2023 for AUM in the region as part of the broader European market.
  • However, increasing financial market sophistication in South Eastern Europe and greater adoption of investment products, as well as proprietary data from individual GPs, indicate that AUM placed into alternative investment funds increased at least fivefold over the observed period.
    ‍
• PE penetration trend
  • The average private equity investment as a percentage of GDP remains low already in the CEE (around 0.2% - 1.0%, depending on the data source) and even lower in the SEE region compared to Western Europe (about 2.0%). However, the SEE region is expected to continue its upward trajectory as it quickly closes this gap, offering attractive returns for investors.
    ‍
• LP landscape evolution trend
  • In 2017, institutional LPs investing in AIF in the region were relatively scarce, and the same applied to HNWIs and family offices. Fast forward to today, and the LP landscape is expanding at an extremely fast pace, with total to-date dry powder exceeding EUR 1.0 billion.
    ‍
• ALFI Funds “quick snapshot”
  • Best practice reporting in LP relationship management
  • Humble, hungry for success, and honest partners
  • Multi-class investment strategy rationale not replicable by any other GP in the CEE/SEE region
  • Downside protection stemming from different uncorrelated funds managed, not replicable by any other GP in the wider SEE region
  • Proven track record of fund performance

As per H1 2024:

Current Fundraising and Expansion Timeline:

• Funds Sought and the Use of Funds:
  • EUR 25-30 million minority stake funding future GP commitments and geographical expansion
  • Expected returns with high downside protection: 30% IRR, minimum 3x MoM over the next 4-5 years or longer term (10-20 years) strong yield play

If you'd like to explore this topic or discuss opportunities further, feel free to reach out to me at: primoz.karpe@cedars.si.

‍