The private equity (PE) market tends to polarise opinions. To its advocates, PE offers the prospect of higher returns and diversification benefits. Its detractors, meanwhile, point out that this comes at a price, with concerns over fees, transparency and how long it takes for money to be deployed and profits to materialise.
However, there is one area of PE where those factors don’t weigh as heavily: co-investments. Through this structure, private equity funds (known as general partners, or GPs) offer select investors (limited partners, LPs) the opportunity to invest directly alongside them in a specific transaction.
In the past two decades, co-investment funds have raised over USD175 billion. Yet PE continues to expand, and we expect co-investments to grow too.
For GPs, one of benefits of co-investment is the ability to invest more in firms they consider attractive, but which would otherwise be too large relative to their fund size (GPs are often subject to concentration restrictions, limiting how much capital they themselves can invest in a single company).
For LPs, a key advantage of co-investing is direct access to high quality private companies. Rather than investing in hundreds of firms through a fund-of-funds vehicle, a co-investment strategy is much more focused (typically in 25-30 companies) while retaining adequate diversification across GPs, countries and industries.
Another benefit is the fact that co-investments are deployed much more rapidly (usually over two to three years) than traditional PE funds of funds, which can take six to seven years to reach full investment. Earlier deployment can help mitigate the problem embodied by the J-curve, or the tendency for PE investments to deliver capital losses in the early years of their life before generating gains. This is borne out by our own 30 years’ experience of co-investing at Pictet.
Ultimately, the net return is boosted by the fact that GPs typically offer co-investments free of the usual management fees (1.5-2.0 per cent) and performance fees (20 per cent). This is significant in an asset class known for its high fees.
However, attractive co-investment opportunities are not always easy to access. GPs tend to only offer deals to their most trusted partners. LPs, meanwhile, need a lot of experience and expertise to assess the deals offered and carry out due diligence. For most investors, this route is effectively closed. Unless, of course, they opt for a co-investment fund.
Co-investment funds are run by managers that have close relationships with GPs and use this to source deals which they thoroughly vet with the help of sector specialists before including the best ones in a co-investment portfolio for clients. The end investors can thus access choice investments at reduced overall fees and with shorter deployment times relative to a PE fund of funds.
It’s clearly a bottom-up, opportunistic approach, but the wealth of opportunities aids portfolio diversification across regions and sectors. Geographically, the most attractive opportunities can be found in North America, Europe and – to a lesser but growing extent – Asia, particularly China. Among industries, we see strong potential in services, healthcare, tech and consumer (not least in areas of sustainable consumption and circular economy). Private equity investors are also in a good position to capitalise on the green transition, by investing in companies which contribute to a reduction in greenhouse gas emissions, reduced pollution and which develop enabling technologies.
Our preference is for asset light companies, which are more nimble and agile than firms that require high levels of capital expenditure. Selecting market leading companies that enjoy pricing power is also an important consideration, particularly in the current environment of increased inflation.
It’s also important to diversify across different types of PE strategies, balancing out less risky buyout deals (mature companies with positive cash flows, often leaders in their fields) with some growth and venture investments (which target newer companies, whose products are not yet proven).
All in, we believe co-investment represents an attractive, opportunistic add-on to a diversified portfolio, alongside other private equity investments.
We have more than 30 years of experience in co-investments, with over 300 deals executed to-date, and 141 of those already realised. We've been investing in private equity since 1989, and currently manage USD27 billion in assets.
Around 60 per cent of the deals offered to us by our vetted group of GPs are rejected each year, with only the best ones chosen.
We have a strong track record of risk-adjusted returns across our co-investments in particular and private equity portfolios in general.
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