Investors Are Seeking More Support for Private Equity Co-investments

The uptick in outsourced co-investment platforms is part of ‘the next generation of thoughtful portfolio construction.’

By Dietrich Knauth

Pension funds are increasingly seeking outside help with their private equity co-investments, looking for partners that can help them build a more diversified co-investment portfolio, see more deals, and react faster to opportunities.

Pensions typically invest in private equity funds as a limited partner, paying a management fee of two percent of committed capital plus a 20-percent “carried interest” fee on higher profits. Co-investments offer limited partners the chance to invest in a company alongside a private equity firm, but outside of a traditional fund structure, often with no management fee and no carried interest. While LPs like the fee breaks, PE firms can use co-investments as a perk for key investors, or to invest in deals that may be outside the scope of their fund’s mandate, such as getting around a provisions that limits the percentage of a fund that can be invested in a particular company or a particular industry sector.

Despite those benefits, co-investment discussions are “frustrating, and often fruitless,”according to a June 2019 paper by Hamilton Lane. A majority of private equity GPs surveyed by Hamilton Lane said that less than a quarter of LPs that ask for co-investment are actually executing on those opportunities.

Most limited partners, pensions included, don’t have the bandwidth to respond quickly when an opportunity arises, let along evaluate enough deals to build a diversified portfolio of co-investments, according to Richard Hope, a managing director on Hamilton Lane’s global investment team. An LP that can quickly sign off on a deal – or even quickly say “no” – will spare a GP the distraction of trying to scare up extra capital at the same time it is negotiating a co-investment deal, Hope said.

“GPs want certainty of capital,” Hope said. “In a competitive deal market, GPs want to know who’s with them, and how quickly they can respond.”

Despite the challenges, the value of co-investment deals has more than doubled since 2012, reaching $104 billion in 2017, according to a 2018 report by McKinsey. Hamilton Lane attributes much of that growth to dedicated co-investment funds and more bespoke solutions run by institutional managers.

Read the full article, as published by Chief Investment Officer:

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