Co-investment has long been a feature of private equity buyout transactions and lately has been increasing in popularity. Private investing continues to produce returns that are superior to public markets as assets under management and returns have grown. Since 2000, private equity investing has outperformed the S&P index by 5 percent, and assets under management have climbed from $1 trillion to over $8 trillion in that time. One way managers have deployed this excess capital has been by offering investors co-investment to supplement their traditional investment offerings.
Private equity firms seek co-investors for several reasons. First, they enable managers to make larger investments without dedicating too much of the fund’s capital to a single transaction, effectively reducing exposure to any one fund investment, and thereby preventing the manager from sharing the deal with competing firms. Typically, co-investors are existing limited partners in an investment fund complex and are managed by the lead sponsor in the transaction.
Second, there are cost efficiencies for co-investors which lead to greater returns since co-investments typically don’t charge management fees or carried interest. Co-investments are often passive, and this has become particularly attractive for millennial investors who are growing accustomed to similar strategies that are reliant on technology. Moreover, middle market co-investment funds—those funds having $100 million to $4 billion assets under management, with vintage years 2014 or later—has seen returns of 15.5 percent, compared to returns of 12.5 percent of traditional buyout firms.
Finally, co-investment strategies offer investment selectivity and provide additional opportunities to investors for especially attractive transactions with low financial entry points. Co-investments enable managers to move quickly under tight deadlines and become another way for managers to engage with their investors and to customize investment solutions. In addition, co-investing frees investors from fretting over the responsibilities of controlling the investment or monitoring the operating company.
With rising private assets and steady returns, co-investing isn’t expect to decline any time soon. According to surveys conducted by Preqin, 42 percent of managers and 34 percent of investors expect increased co-investment over the next five years.