There is no doubting the fast-growing popularity of co-investing among limited partners. For years, institutional LPs of all types and sizes have looked to grow their allocations to co-investment opportunities with general partners for many reasons, including the fact that co-investments are frequently offered on a no-fee, no-carry basis. This reduced fee burden is essential to driving higher risk-adjusted returns.
Co-investments can also be quite beneficial to GPs, especially in helping to right-size equity checks and deepen relationships with LPs.
In a slower private equity environment, co-investing has become, if anything, even more attractive to both LPs and GPs. In a challenging fundraising market, for example, co-investing has emerged as a key incentive for sponsors to bring investors into their new funds.
But while the flow of co-investment opportunities seems to have accelerated, this has not always translated into increased activity.
A significant barrier to widespread LP participation since 2022 has been illiquidity owing to overallocation to private equity and weak distributions from GPs.
This and several other factors suggest that while co-investing should perhaps be reaching record levels today, it has in many instances begun to wane, LPs tell Buyouts.
‘I’m stopping doing co-invest’
Fundraising has slowed to a walking pace, with exits and distributions freezing up amid a stodgy M&A market. In the face of this, the bespoke and opportunistic upside that co-investing offers has proven to be an asset, for both GPs and LPs alike.
For some years now, co-investing has been the favored avenue for LPs as a cheap and easy way of entering the private equity market. Its popularity has grown as private equity has increased its share in LPs’ portfolios, with Buyouts data showing that in 2021 funds had committed an all-time high of $19.3 billion to co-investments spread across 229 funds.
Given the tight fundraising landscape, with minimal dry powder available, many market insiders have highlighted that the conditions are ripe for an explosion in co-investing private equity.
For some LPs, this expectation has manifested. “There’s no doubt that there is more interest from the institutional LPs to co-invest more,” Jason Strife, head of private equity at Churchill Asset Management tells Buyouts. “We’ve been experiencing that trend for literally 15 years, and amid that growing popularity of co-investment, our program has grown 15 years in a row.”
This success hasn’t just been localized to Churchill, either. A spokesperson for Hamilton Lane notes that the firm had seen the “highest levels of co-investment activity ever” this year.
But this anecdotal popularity isn’t borne out in Buyouts’ data. In 2023, only $8.7 billion was raised for co-investing, more than $10 billion less than the high watermark of 2021. And the numbers for 2024 showing the continuing decline are even more dramatic, with $4.58 billion raised.
“A lot of LPs say they’ll do co-invest but they’ve slowed down or pulled out”
Scott Ramsower
Teachers’ Retirement System of Texas
While some LPs have reported seeing more activity in the co-investment space, the market has not quite exploded for everyone in the same way. In fact, as some LPs see their liquidity dwindle, there has been a move to retract co-investment dollars, rather than continue to add more allocation.
“A lot of LPs say they’ll do co-invest but they’ve slowed down or pulled out,” notes Scott Ramsower, head of private equity funds at Teachers’ Retirement System of Texas and member of Institutional Limited Partners Association’s board, in an interview with Buyouts.
“Let’s say you put $100 to work last year and your model says you should put $80 this year. And historically you’ve wanted 20 percent of every dollar to go into co-invest.
“So, you have a question to ask yourself: do you lower both funds and co-invest pro rata to get to $80 total or just not do co-invest this year so your funds are $80 this year, which is flat with the $80 you did last year?
“That’s a decision everyone is asking themselves and a lot of them are just deciding: ‘You know what, I’m stopping doing co-invest.’”
Pension pullback
Above all LP types, it is pension funds that have had to face this issue most urgently. Data released by Buyouts in August 2024 revealed that 64 percent of private pension funds reported themselves as being overallocated to private equity. Fifty-five percent of public pension funds were also reported to be overweight in private equity exposure.
A third of all pension funds, both public and private, and sovereign wealth funds cut their private equity allocations in the year to date up to July 2024.
64%
Share of private pension funds reporting themselves as being overallocated to private equity, according to Buyouts data
Pension funds’ pullback from private equity in 2024 has extended to co-investing as LPs prioritize other investment sectors in their portfolios.
“If you’re an LP, where your allocations are tight and you want more liquidity, you’re probably reserving capital for your most coveted set of general partner relationships,” says Mark Hoeing, CEO of CommonFund, in an interview with Buyouts.
“Doubling down by getting co-invest and being kind of co-invest centric, if you’re in that position, is probably not your highest priority. It’s more reserving capital for those managers who have really delivered, and continuing primary commitments or investments as your strategic allocations, making co-investments much more opportunistic.”
And some have not been impressed with the performance of their co-investments.
“These co-invests are by definition more concentrated positions,” Ramsower notes. While that volatility is attractive in bullish markets, current conditions may be causing LPs to say “tap the breaks on co-invest,” he adds.
Pensions funds, which prioritize consistency of returns in their long-term investments, are particularly vulnerable to the volatility of co-investments.
“What we’re observing is really a bifurcation in the co-investment market”
Jason Strife
Churchill
But, while some pension funds and smaller LPs look to draw back their co-investment positions or struggle to continue to commit capital to private equity, others have found themselves well positioned to take advantage of their retreat, as GPs look for help rounding out their fundraising.
“I think smaller fund sizes, protracted fundraisings, looking at sharing equity tickets, it’s all come together to create some interesting dealflow for co-investors,” says Hoeing.
“We’ve seen probably some adjustment in pricing in terms of what companies are trading at and there has been a need for more equity in the transactions as the cost of debt increases, meaning less available debt to finance transactions.”
With the rise in financing costs in recent years, GPs have needed more equity to do their deals cost effectively, he notes. “If the fundraising landscape has been slower, then it’s great to have LP co-invest partners who can look to round out equity checks.”
Over the last year, this dynamic has worked to help foster relationships between GPs and those LPs that are more suited to co-investing at scale and across asset classes.
LPs that have already carved out allocations to co-investing across asset classes and that have dedicated teams to the strategy are the ones that insiders believe have been best placed to engage in the co-investment space over the last year.
Bifurcation
“What we’re observing is really a bifurcation in the co-investment market,” notes Churchill’s Strife. On the one side, he says, are small institutions, without dedicated co-investment teams, that typically want to make discrete investments into platforms that have already been through due diligence and acquired by their buyout managers – effectively taking a passive syndication role.
“I think the way we look at co-investing is it’s a relationship builder”
Kenneth Binick
Hamilton Lane
On the other side are Churchill and its peers, he says, who have in-house investment teams and want to act more as valued investment partners, getting calls from relationship GPs early in the deal process. One insider explains the advantage of size: “I think you have to have a little bit of differentiation if you’re going to raise capital in this market,” Ken Binick, co-head of direct equity at Hamilton Lane tells Buyouts. “This is the most cost-effective way to access private equity markets, but you need to have a defined strategy, and you need to have scale. There are only a few co-investment players out there that have this scale, at least on the primary side, that I think you need to be successful.”
The ability to scale, as Binick highlights, has helped some GPs grow to meet the expanding demand for co-investments that has come over the last 10 years.
Beyond just increasing the number of co-investment opportunities, the track record established by these larger firms has given them the reputation and relationships to help weather this arid period for fundraising.
What this has amounted to is an alternative arena to primary investing that has helped LPs and GPs retain partnerships without the privilege of regular exits and fundraisings.
“I think the way we look at co-investing is it’s a relationship builder,” Binick adds. As fundraising slowed, interest rates went higher and leverage became expensive or difficult to obtain, GPs turned more and more to co-investing to keep the machine running, he says.
“There was an equity gap that they needed to fill, and they were calling the most strategic partners, while others were on the sidelines, and were not able to be there.”
Click here or on the image for more on why co-investment funds will likely remain a niche
Reduced GP incentive
Over the past three years, as GPs encountered more challenges to launching and raising funds in a timely fashion, many began to offer carrots to LPs in the form of new terms. Of these terms, co-investment opportunities hniave perhaps been the single most important that sponsors can offer as an enticement to LPs to come into their new funds.
However, such incentives will not be offered indefinitely and may soon be withdrawn, especially by large, well-established GPs.
“In the past, you could put 75 percent of your money in fee-related and 25 percent in co-invest with very low fees; some of them none,” says Jim Pittman, BCI global head of private equity.
“But for some of the bigger funds, that flexibility may start to turn in the opposite direction, as they’ve cornered the market share they’re looking for and want to improve their fee base. I think there’s more flexibility in the next 12 months, but that starts to turn – particularly for the bigger funds – in the future.”
The marginal benefits that GPs are seeing from co-investing could be shrinking, and not necessarily just for larger GPs.
At a PEI Group event last year, one CFO of a mid-market manager ruefully echoed Pittman’s remark, saying that the economics of being a fund manager in the first place were threatened by the amount of co-investment their relationship LPs demanded. “It used to be that our funds were 80 percent primary investment and 20 percent co-investment,” the CFO said. “Now, it’s the other way around.”
But, in a consistently difficult fundraising environment, there are likely to be other managers who continue to turn to co-investment to help round out their goals.
Some expect a slightly better fundraising market in 2025, though perhaps not a return to peak levels of growth, which must await an improved supply-side in the form of more liquid LPs. This in turn is contingent on healthier distribution volumes. Until this happens, new, mid-market and smaller GPs might need to retain co-investing as an incentive.
LPs of all types and sizes will continue to crave co-investing. But it may require increasingly more liquid investors, and by extension an improved fundraising environment, to restore the ability of institutional LPs to participate in the co-investment opportunities on offer.
While the fundraising incentive factor will eventually disappear, deeper GP-LP relationships gained in recent co-investing, together with the greater experience and capabilities acquired by institutional LPs in the process, will perhaps create a more durable basis for future activity.
