Managing Principal, MC Square
by Marino Marin, Managing Principal MC Square
Co-investment has now definitively emerged as a preferred alternative structure for investors seeking access to the Private Equity market and the outlook for this strategy is robust. It provides Limited Partners (LPs) such as HNIs, Family Offices, and institutions with access to investment opportunities which traditionally have only been available to major PE funds. However, while traditional GPs have generally been offering these opportunities to LPs, a new breed of new players is emerging – the independent co-investment platforms.
A traditional co-investment strategy provides a two-way benefit to the parties involved in the transaction. LP groups may have the capital to invest but are resource-constrained when identifying investment opportunities. On the other hand, GPs have the know-how of investing and managing the assets but might not have the adequate capital required for an investment opportunity.
In a GP-led co-investment, the LP invests directly into the GP’s investment opportunity and earns a percentage of the portfolio returns on top of the standard LP profit share. This additional return enables the investor to move up to a higher risk-reward line.
Why are GPs now encouraging Co-investment structure?
Fund managers benefit from reduced risk exposure to their investments, building stronger relationships with LPs and gaining access to additional capital for deals. Providing co-investment opportunities to LPs acts as a differentiator and as a selling point for GPs. It makes the GP’s fund more attractive to investors while allowing access to a greater pool of capital.
Co-investing also helps GPs preserve capital for the next deal. They seek to reduce the capital invested in each deal in order to sprinkle capital into more deals rather than concentrate it into fewer deals. Additionally, offering co-investments can also help reduce LP demands for lower management fees.
Recent years have seen an increase in allocation by Family Offices in PE alternative investments. 57% of the global investor pool actively invests in alternative asset classes.
Co-investing is attractive to LPs as it waives off the fee charged by fund managers and provides them with increased transparency on where and how their money is invested. In this way, co-investing ensures higher returns compared with investment in traditional PE funds. It also offers deployment of capital at a much faster rate, with access to a wider range of opportunities, while potentially mitigating the J-curve.
Through co-investing, Family Offices can leverage due-diligence advisory from experienced General Partner (GP) firms, which otherwise would be a huge task given the limited resources at their disposal. Co-investment provides investors with a “peek behind the curtain,” allowing a better understanding of a GP’s sourcing capability and operational skill – thereby providing enhanced primary fund intelligence. It also helps create a network of like-minded investors, providing better information flow about available investment opportunities within the investor community.
The emergence of new Players
As interest in co-investments is increasing from LPs, the market has seen the emergence of a few independent co-investment platforms that are an additional and potentially more interesting alternative for LPs compared to traditional GP co-investment while preserving the same basic advantages to the LPs. These platforms originate deals independently and select the most appropriate sponsor to co-lead the transaction as well as investing. This brings additional advantages for the LPs. Firstly, the LPs can enjoy a more constant and diversified deal flow deriving from the continuous origination efforts of the co-investment platform. Secondly, they can leverage the experience and the independent advice of the co-investment platform to select the most appropriate sponsor for a specific deal based on the sponsor’s performance in a specific sector and geography.
Family Offices and LPs are increasingly recognizing Private Equity co-investment as being a means of generating strong returns whilst exercising greater control over their portfolios. As per the latest available data, the allocation of assets in Private Equity by Family Offices is around 21% – the highest proportion of any asset class. 10% to 12% of this (~2.5% of the total pool) represents capital committed to co-investments. A major share of this co-investment strategy allocation goes to Real Estate (60%), followed by Technology, Healthcare, and Finance & Insurance.
Based on a recent survey , 45% of GPs indicated that they would offer more co-investment opportunities to their LPs. In addition, 82% of LPs planned to increase their co-investment allocation further, as compared to traditional fund investments. From a returns perspective, more than two-thirds (68%) of investors have generated higher returns from co-investment activities in 2017.
Over the longer term, co-investments are likely to form a larger part of the investor portfolio, as 34% of surveyed investors plan to increase their co-investment activity, while only 3% intend to reduce it.
Given the benefits to LPs, it is understandable why LPs/Family Offices are pursuing co-investing. Their performance continues to be strong, and investment opportunities seem to be growing in number. This, coupled with the emergence of qualified co-investment platforms, will be a driving force in the PE co-investment industry going forward.
Source: (1) The UBS / Campden Wealth Global Family Office Report 2018
(2) Preqin Investor Outlook: Private Equity H2 2017
(3) Conscious Coupling: Family Office and Private Equity co-investing 2017