Key Takeaways
- • The share of Limited Partners (LPs) using co-investment in private equity rose from 24% in 2012 to 71% in 2021, according to the World Economic Forum.
- • LPs cite knowledge exchange with top General Partners (GPs), risk management and higher alternatives allocations as motivations, not only fee reduction.
- • Some of the largest LPs, with cheque sizes above $500m, treat fund commitments as a route to co-investing and seek a 1:1 fund-to-co-investment ratio or more.
- • Per the Milken Institute Asia Center, LPs who succeed build strategic GP relationships, act with a "firm yes, quick no" approach and avoid second-guessing agreed terms.
- • 37% of LPs cite a lack of available co-investment opportunities as a hurdle, and GPs complain that LPs lack the capabilities to support deals.
Summary
Co-investing, in which LPs take a direct stake in an asset alongside their GP, has expanded sharply in private equity over the past decade. According to the World Economic Forum, the share of LPs using co-investment rose from 24% in 2012 to 71% in 2021. While co-investing has often been viewed as a way to reduce fees, research cited by the Forum shows LPs are also motivated by risk management, a larger alternatives allocation and the chance to learn from top managers about industries, trends and best practices.
GPs also benefit, since an LP can supply capital for deals larger than a fund's limit for a given industry or geography, and GPs would rather share such deals with LPs than with competitors. Competition among LPs for access is intense. Some of the largest LPs, with cheque sizes above $500m, treat fund investments as a means to co-invest and seek a 1:1 fund-to-co-investment ratio or more. Still, 37% of LPs cite a lack of opportunities as a hurdle, and many GPs complain that LPs demand co-investments without the capabilities to execute them. GPs now apply an implicit selection process that favours proven LPs.
Drawing on interviews by the Milken Institute's Asia Center with the CIOs of eight large sovereign wealth and pension funds, collectively managing over $2.4 trillion, the article outlines three practices. First, LPs should move from transactional to strategic GP relationships; one LP acted as a trusted advisor during a GP's fundraising, and a pension fund commits 10-15% of new GP funds in return for co-investment rights. Second, LPs should act quickly: a sovereign wealth fund described its "firm yes, quick no" rule, and one pension fund delegated deal decisions to its investment team rather than its board, which meets 5-6 times a year, for pre-approved strategic partner GPs. Third, LPs should maintain trust, avoid reversing agreed positions and "drop the ego," trusting the GP to represent their interests in syndicated negotiations.
The article concludes that private equity is a relationship business and that the LP-GP relationship matters more during co-investing.
GPs also benefit, since an LP can supply capital for deals larger than a fund's limit for a given industry or geography, and GPs would rather share such deals with LPs than with competitors. Competition among LPs for access is intense. Some of the largest LPs, with cheque sizes above $500m, treat fund investments as a means to co-invest and seek a 1:1 fund-to-co-investment ratio or more. Still, 37% of LPs cite a lack of opportunities as a hurdle, and many GPs complain that LPs demand co-investments without the capabilities to execute them. GPs now apply an implicit selection process that favours proven LPs.
Drawing on interviews by the Milken Institute's Asia Center with the CIOs of eight large sovereign wealth and pension funds, collectively managing over $2.4 trillion, the article outlines three practices. First, LPs should move from transactional to strategic GP relationships; one LP acted as a trusted advisor during a GP's fundraising, and a pension fund commits 10-15% of new GP funds in return for co-investment rights. Second, LPs should act quickly: a sovereign wealth fund described its "firm yes, quick no" rule, and one pension fund delegated deal decisions to its investment team rather than its board, which meets 5-6 times a year, for pre-approved strategic partner GPs. Third, LPs should maintain trust, avoid reversing agreed positions and "drop the ego," trusting the GP to represent their interests in syndicated negotiations.
The article concludes that private equity is a relationship business and that the LP-GP relationship matters more during co-investing.
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