Co-Investing was the topic of the day as the SuperInvestor Conference drew to a close in Amsterdam on Friday, and with a broad range of topics covered on this subject matter, we were able to gain perspective on this rapidly growing sector of the private equity market from both prospective investors and fund managers. There can be significant tension during the fundraising process when it comes to co-investment and the various discussion panels sought to tackle where these tensions tend to arise and how they can be managed.
Take, for example, a prospective investor that negotiates ferociously during the fundraising process for co-investment rights and for a fund manager to go above a simple side letter acknowledgement of an investor’s interest in co-investments. A fund manager may agree to this by offering the prospective investor, in priority, access to co-investment rights as part of a preferential group. Panellists representing general partners shared such experiences and went on to note that despite such preferential rights being granted, certain investors failed to take up a single co-investment offering during a fund’s investment period despite numerous opportunities to do so. A fund manager’s frustration in such a situation is clear to see.
To balance the position, consideration was given to how limited partners may view co-investments. First and foremost, without access to co-investment opportunities, the ability to access the broadest range of deals is curtailed. It is in a limited partner’s interests to push, to the extent possible, for the preferential co-investment rights that may be available, irrespective of whether such opportunities are eventually taken up.
The range of limited partner’s perspective and deployment of capital into co-investments covers a broad spectrum. At one end of the spectrum are limited partners that appear willing to co-invest at every available opportunity - the chance to accelerate the deployment of capital seemingly outweighing and reducing/eliminating the investment decision making process on a co-investment by co-investment basis.
On the other hand, as Elias Korosis, Partner of Hermes GPE indicated, most limited partners treat co-investment opportunities extremely carefully and undertake as much due diligence as possible before committing new/additional capital to any investment. Some investors have an investment ratio across the co-investment spectrum in the region of 10%. Since 2011, for approximately 1,000 deals sourced, Hermes GPE have invested in approximately 100 co-investments, demonstrating the deep and careful analysis that goes with each and every opportunity.
With consideration given to the risk and reward of co-investment, it is clear that it demands careful analysis on an investment by investment basis. Take, for example, a top quartile fund that has historic and current returns exceeding market levels. The opportunity to put additional capital to work sooner is an enticing proposition. However, as many panellists noted, due to the levels of exposure co-investments can create, it may only take one bad deal that an investor has co-invested in, that may result in a small impact in a particular fund’s overall performance, to have a significantly greater negative effect on an investor’s overall portfolio return. Diversification across co-investments is, therefore, also key.
There were many messages that general partners sought to relay to prospective investors and vice versa throughout the day. Building relationships with general partners with a view to accessing additional opportunities is a long process. It is also one that has to be managed on an ongoing basis. A limited partner granted co-investment opportunities that they then persistently turn down, cannot reasonably expect to remain a part of a preferred group over time.