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LP co-investment deal value sees three-fold increase since 2013

By Elizabeth Pfeuti – As institutional investors, such as pension and sovereign wealth funds, build internal teams and grow increasingly sophisticated, they are wanting a more direct role in how their assets are allocated. Nowhere has this trend been more apparent than in the rise of co-investments with private equity partners.

In the last three months, major investors including some of the largest pension plans in the US have outlined their ambitions in this area. 

Commenting on its newly inked partnership with GCM Grosvenor, chief investment officer of the USD31 billion South Carolina Retirement System Investment Commission Geoffrey Berg said he believed the program would allow the pension “to efficiently and seamlessly execute co-investments and become one of the premier co-investment partners to private equity sponsors”. 

The US’s largest public pension The California Public Employees’ Retirement System, has dedicated around 5 per cent of its overall private equity portfolio to co-investments.

These investors are not alone. 

“We used to deploy USD200-300 million per annum in co-investments 10 years ago and we now deploy USD2 to USD3 billion every year,” says Corentin du Roy, Managing Director focusing on Harbourvest Partners’ co-investment strategy. 

Additionally, research cited by Mark Zünd, Partner and Head of Investments at Unigestion Private Equity, shows limited partner co-investment deal value has increased three-fold since 2013. 

“Today, according to Cambridge Associates, 20 per cent of overall private market activity is for co-investments, which are sought by most LPs and form an integral part of LP-GP relationship,” says Zünd. 

“These types of investments have been ‘democratised’, so to speak,” says Zünd. “If in the past, deals were mostly ad-hoc syndications; today, investment opportunities follow a structured and transparent process.”

Additionally, ten years ago co-investments were reserved for a limited number of favoured investors who had established relationships with the GP; today, they are offered to the wider investor base, says Zünd.

This wider investor base is only too happy to reap the benefits of being a real partner rather than just another investor in a fund, according to Nick Warmingham, Managing Director, Cambridge Associates.

“Co-investment does have a fee advantage and it gives an LP certain control over what goes in a portfolio rather than going into a [blind pool] fund – it should be a known quantity, even if there are follow-on investments that are difficult to predict,” says Warmingham. 

Aside from the financials, there are other upsides, too. 

“LPs get to see how the manager has underwritten the deal through a co-investment process,” says Warmingham. “It is a chance to gain insight into how that manager works and can be a mutually beneficial exercise in getting to know each other better.”

For Louis Young, Co-Founder and Managing Director at Augusta, this is a distinct benefit to a manager working in a specialist field.

“Investors want to be closer to the deal,” says Young. “They are aware of what happened in the financial crisis when the tide went out…”

Augusta is the largest litigation and dispute funding institution in the UK, but, Young admits, it is not an everyday investment. 

“It is increasingly on the radar,” he says. “Those that show interest in it want to know what it entails and to understand the types of claims their investment will fund.”

Being a partner, rather than just an investor enables that to happen more efficiently.

Du Roy at Harbourvest says there is also more interest in co-investment from GPs than ever before. 

“Private equity managers have developed a preference to avoid “club” deals, which are deals co-led by multiple GPs, when possible,” he says. “They have also become more disciplined post the Great Financial Crisis on portfolio construction parameters, such as maximum deal size and proper diversification.”

This increased supply has been met with increasingly sophisticated LPs who “have developed their capabilities and appetite to partner with their GPs on co-investments and, in doing so, provide an alternative to the GPs who otherwise may have had to team up with competitors,” says du Roy.

These LPs are not all alike, however, and subject their partnering GPs to various levels of challenge.

“On one hand, some LPs take a very light touch approach to co-investment due diligence, essentially pre-approving co-investment opportunities from certain managers in their portfolio that they know well,” says Warmingham. “On the other, some LPs will leverage the manager’s due diligence to underwrite the deal according to their own analysis.”

This second approach requires separate skills within the internal investment team, something that the larger institutional investors increasingly have, and can use to their advantage in co-underwriting deals alongside managers, according to Warmingham. 

“They carry out their own analysis of the company – benchmarking it against competitors – and its wider market,” he says. 

Taking this approach requires a firm commitment from LPs, however as it comes at a substantial cost. 

“The downside is mainly that it takes significant resources with a robust investment team, flexible decision processes, legal, tax and back office support to co-invest successfully,” warns du Roy. “It is important to build appropriately diversified portfolios underpinned by a comprehensive sourcing approach and a rigorous investment selection and decision process.”

Despite the expense and dedication needed, the number of LPs lining up to be partners rather than just one in a crowded pooled fund seems to be rising. 

“It is taking off,” says Young at Augusta. “Co-investment in litigation and disputes funding, where one party has the expertise and knowledge, and the other brings the capital is a model that is gaining popularity. With large deals funding a portfolio of cases, it’s a solution for some investors.”

For Warmington, there is more noise than action for the moment, but that will change as LPs gain the expertise to execute deals reliably. 

“Over the long term, as people get more comfortable with the idea of private assets, we are going to see a lot more co-investments,” he says. “The number of publicly listed companies is falling, while the private markets are expanding. GPs are getting more sophisticated in their approach to investor relations and can talk investors through the process more clearly.” 

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