Hermes and Gartmore lead the consolidation of the fund-of-funds industry with the creation of Hermes GPE. Deborah Sterescu reports.

As many have suggested, consolidation in the fund-of-funds industry is inevitable and today, Gartmore Investment Management and Hermes Fund Managers have announced the first major development in the European arena thus far, merging their private equity fund-of-funds businesses to create Hermes GPE.

The newly-created business, which will have a total of £4.1bn of assets under management, will benefit from the existing experience of both private equity teams, whose histories each date back to the early 1990s. As a result, investors are expected to have access to increased resources and greater economies of scale necessary to cover the global private equity market.

"If you're going to give investors the best offering for global private equity, you have to have a scaled up resource team. You can't do it with two or three people sitting in one office," says Alan MacKay, chief executive officer of the newly established Hermes GPE, and previously lead partner for 3i where he worked in several senior management roles over the last 20 years.

In fact, MacKay predicts the merger to be the start of a greater consolidation trend in the fund-of-funds industry. "The vast majority of big pension funds have their capital in a fund-of-funds channel, and I think many are now reflecting during this quiet period of private equity and thinking about where their money is best put to work. I believe a number of fund-of-funds will begin to realise that they have to scale up their teams to give a global offering. I'm not sure there is a market for country-specific funds-of-funds anymore."

Indeed, Gartmore and Hermes are not the only ones to get smart. Their merger follows the acquisition of fund-of-funds manager Pantheon Ventures by US-based Affiliated Managers Group for $775m back in February.

In this dry climate, the balance of power has shifted to LPs and many GPs will have to re-think their investment strategies. "For an investor interested in international private equity, the best returns would come from a sensibly balanced distribution of private equity. You have to have the track records, resources and the scale to cover each area of the asset class including buyouts, growth capital, infrastructure, etc," says MacKay.

Many pension funds used to invest with a few fashionable, personality-led houses, focusing solely on big-name funds. However, this has all changed now, according to MacKay. "You can't invest with personalities and big names anymore. You have to invest with teams that are close to their markets. Whether the fund is focused on a sector or a country, it has to live and breathe that space. There are no free meals in private equity anymore – you have to have the credibility to command capital."

For some, this credibility is based on a manager's commitment to a responsible investment ethos, as well as its experience in any given sector or region. Hermes GPE, for example, has set responsible investing at the heart of its investment approach. "A lot of people question why you would make an issue of responsible investing. But in the real politik of private equity, you are recognised and rewarded for this approach. Good corporate governance and responsible investing are important, especially in the under-developed markets. Previously, a lot of people paid lip service to this idea, but increasingly now it commands respect and reward," affirms MacKay.

In his new role, MacKay will work alongside co-chief investment officers Susan Flynn and Peter Gale, who previously headed their respective teams at Hermes and Gartmore. According to MacKay, Hermes GPE may consider further acquisitions in the future – a sign that the fund-of-funds industry is set to shrink in the coming years.