Private market co-investments: Join our club

As institutional investors seek new ways to extract value from their portfolios, a growing number are setting aside capital for co-investments in private markets.

These vehicles offer investors the benefit of reduced costs associated with asset classes such as private equity, infrastructure and real estate, coupled with potentially higher returns and quicker implementation of deals. But investors need to be prepared to endure a heavy governance burden if they wish to get involved.

Pension funds have been joining with general partners (GPs) to access investment opportunities for the best part of 20 years, but activity has increased since the global financial crisis as investors have sought greater control over their positions and become more scrupulous over fees.

There are essentially two ways to gain access to co-investment: one is through a co-investment fund run by a manager who assumes responsibility for the investment opportunities; and the second is to invest in a segregated private markets vehicle alongside the GP.

It is difficult to keep tabs on these deals as many are originated off-market, but according to a Preqin survey of more than 440 institutional investors across the globe, 50% are considering or already accessing infrastructure through co- investment, while for real estate some 40% are already or considering investing through separate accounts.

Investing in a fund naturally carries with it an extra layer of fees and an investor is beholden to the manager’s choice of investment opportunities. This approach could however benefit smaller schemes which are happy to outsource the investment decision-making.

One of the benefits of investing alongside the GP as a limited partner (LP), is the ability to obtain rights to place additional capital to the pro rata share of the fund. Also, if an investor is already invested in a fund then there will often be no fees to pay to invest alongside the GP as they are ‘part of the family’, so to speak.

As Sanjay Mistry, director of private debt at Mercer, says: “If you go into a co-investment directly on the basis you are already invested in the fund, you are essentially investing on a no-fee basis and you are leveraging the skills of the private equity manager.”

A recent case in point was Hermes Infrastructure’s acquisition of the UK government’s 40% stake in Eurostar as part of a consortium with the Caisse de dépôt et placement du Québec (CDPQ), a Canadian institutional fund manager (the two parties own 10% and 30% respectively).

The Santander UK Group Pension Scheme also owns 4% after capitalising on its position as an investor in Hermes’ fund and investing in a segregated mandate alongside the fund.

Santander UK director of pensions Antony Barker explains the fund strategy was not as opportunistic or value-added as Santander was looking for in terms of its target.

“We suggested setting up the segregated account alongside it where we could tweak the asset allocation accordingly,” says Barker. “Then we would be working on a deal-by-deal basis.”