PEI 300: How co-investing has changed over a decade

More investors are progressing from syndicated co-investing to co-underwriting as they seek greater control over their private equity portfolios.

Co-underwriting deals was historically the preserve of the most sophisticated investors, but over the past decade more have realised the mutual benefits of becoming a more hands-on partner to their GPs.

Appetites for co-investments have soared as LPs look to increase their allocation to exciting sectors, deepen relationships with GPs and secure more appealing economics. Doing so has also given LPs greater control over their portfolios as the industry shifts from the one-size-fits-all model of old.

The true scale is hard to gauge, but Triago puts “shadow capital” – including co-investment, separate accounts and directs – at $206 billion in 2019, of which approximately $66 billion was for co-investing.

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“It’s a marked difference from 10 years ago,” Sweta Chattopadhyay, head of Bfinance’s private equity advisory and an alum of Universities Superannuation Scheme, RPMI Railpen and Adveq, tells Private Equity International.

“Over the past five years, there’s still been a pool of investors that are reliant on GPs for syndicated co-investments, but more and more it’s moving towards co-underwriting. Part of that is wanting to have more understanding earlier of transaction dynamics and wanting to be more involved with the portfolio companies.”

Teacher Retirement System of Texas said last year it would begin to pursue co-underwriting opportunities in lieu of syndicated deals as the latter had become commoditised.

“Co-underwriters eat till they are full, and syndicators eat the leftovers,” managing director for private equity Neil Randall said at the time, noting the process is more labour-intensive and comes with inherent uncertainty.

Head start

Co-underwriting can benefit LP and GP alike. The former gets a head start on attractive dealflow, a deeper understanding of a GP’s deal process and expertise in a preferred sector; the latter can share the burden of due diligence and potential broken deal costs.

London-headquartered BC Partners has provided approximately €9 billion of co-investments across 31 portfolio companies for 89 different LPs since 1994, per its website. Of this, €3.8 billion was co-underwritten or co-sponsored by 12 unique investors. “Over the past decade we’ve witnessed a palpable change in the risk appetite of many LPs, who are now more willing to share the burden with the manager,” says partner Nikos Stathopoulos, adding investors now have a greater understanding of the skillset and infrastructure required to be a successful co-underwriter.

Those with the means and readiness to do so can be well-rewarded. Alaska Permanent Fund Corporation’s $1.8 billion co-investment portfolio had delivered a 61.5 percent five-year net return as of 30 June 2019, versus 18.4 percent for PE funds.

“As we’ve seasoned our co-investment programme, we’ve naturally found different thematic areas we want to get a little bit smarter on, so if a GP can help us with that effort and direct relevant dealflow in that area, they become very important,” Yup Kim, senior portfolio manager at the $62 billion institution, notes.

“These GPs aren’t always top-decile or oversubscribed, but they’re very committed to a partnership approach and these have become some of our most rewarding relationships.”