Evening Brief – 10.16.23
Vying for Co-Investments
CalSTRS, the nation’s second largest pension system, concluded 11 co-investment transactions totaling nearly $500 million in a frenzy of activity in the first half of 2023.
Some of the world’s leading global private equity firms participated in the most recent round, including KKR, Blackstone, Advent International, Apollo, and TA Associates.
The concept of allocating alongside GPs is becoming more frequent in public pension systems. Experts anticipate the trend will continue to increase as allocators seek not only favorable investment terms but also fresh sources of private market alpha as valuation problems persist.
Cambridge Associate’s co-investment specialists Scott Martin, Nick Warmingham, and Jacquelyn Klehm wrote a white paper describing the benefits and drawbacks of co-investing, which appears to be becoming more sophisticated in nature.
The advantages for GPs are numerous, however not immediately tied to fee generation. The additional LP capital enables the GP to manage concentration risk and better oversee the fund’s pace of deployment.
Co-investments may also assist the GP in acquiring larger assets. These transactions benefit buy-and-hold private equity firms because the LP commitment is drawn at the outset to acquire the platform and the remaining is retained for future add-ons.
The team suggests allocating 15% to 30% of an investor’s total allocation to private investments, which could easily amount to billions of dollars in major allocators’ portfolios.
The ability to control deployment pace while growing exposure to specific managers, geographies, market segments, or sectors is attractive to LPs. It also provides a better insight into a GPs sourcing and due diligence procedure.
As one might imagine, the larger the investor, the more likely co-investments are to be included. Aside from the massive CalPERS and CalSTRS pension systems, portfolios managed by the State of Wisconsin Investment Board, the State Board of Administration of Florida, and even the University of Michigan endowment have invested in the structure.
Cambridge discovered that the most effective co-investment structures are those in which $1 billion or more has been invested in the asset class. Some co-investments can be completed by investors with $200 million to $1 billion, but access is difficult. It is practically impossible for those with less than $200 million.
While GPs appear to be more ready to offer co-investments, rivalry for the greatest access to successful companies remains, as the need to increase portfolio performance in a difficult year for valuations is likely at the forefront for both GPs and LPs.