Solo efforts

In the sluggish fundraising environment of the past year, some GPs have created unique ways to structure accounts for their prized LPs as a way to raise capital for investments and build relationships with investors.

GPs are structuring these accounts at just the right time, as more and more LPs are looking for opportunities to co-invest alongside trusted GPs.

The industry will continue to see institutions, especially those with the resources to build strong in-house teams, looking for more unique investment structures where they can have more control over investment decisions and pay lower fees. Firms that seek to cash in on this growing trend should be prepared with creative ways to work with LPs.

“As plan sponsors get more comfortable with the asset class, they have started venturing off and doing much more on their own,” says a fund of funds source. “[These types of vehicles] come with higher expected returns, and higher volatility. When we structure a portfolio, we don’t target more than 10 to 15 percent of the portfolio to co-investment.

Christopher
Witkowsky

“Also adding to it is the lack of capital being raised,” the source says. “Ten years ago, when everyone was piling money into private equity, there wasn’t really as much of a need for some of the co-investments. Fundraising now is difficult, so GPs are going to reach out to co-investors as well.”

One institution to move into co-investments is seasoned private equity LP The Wellcome Trust, a charitable UK foundation. Wellcome recently teamed up with The Blackstone Group to bid for 318 branches of the Royal Bank of Scotland.

Wellcome has over the past few years “transformed our investment policy, combining aligned partnerships with the strongest managers and building in-house resources to own selected assets directly”, according to the organisation’s website.

This move is in line with many other large institutions that are active in private equity, and that are increasingly creating co-investment or direct vehicles.

The largest pension in the US, the California Public Employees’ Retirement System, with more than $200 billion of total assets, said earlier this year it is planning to create “unique structures with select general partners” that charge lower fees and offer more customised portfolios.

In a board presentation, investment staff said CalPERS would also build up its co-investment capability to invest alongside the “highest capability” general partners to gain additional exposure to “attractive companies at lower costs”.

CalPERS has a separate account for co-investment with mega-firm Apollo Management to which it committed $1 billion for investments in senior bank debt and hung leveraged buyout loans. The Apollo Credit Opportunities Fund had an internal rate of return of 11 percent as of 30 September 2009, and that’s with about $952 million of CalPERS $1 billion commitment called. The vehicle is carrying a 1.2 percent investment multiple, according to CalPERS.

It’s hard to make a generalised statement about how co-investment programmes perform. The California State Teachers Retirement System reported its co-investment programme, established in 1996, had a net 10-year return of 3.7 percent, compared to the net 10-year return of 8.5 percent for fund investments.
“Longer term performance for the co-investment portfolio was dampened by two failed co-investments made in the mid-1990s,” the pension said in documents.

Some GPs recognise the appetite LPs have for uniquely structured programmes that allow for co-investments. Apollo said in a recent filing with the US Securities and Exchange Commission that it is seeing more interest on the part of investors to enter into tailored separate accounts.

Apollo also has a vehicle called Palmetto with the South Carolina Retirement System, which as of 30 September had $759 million. The account had committed more than $250 million to investments “primarily in [Apollo’s] European non-performing loan and private equity funds”, Apollo said.

“Palmetto was established to facilitate investments by such third-party investor directly in our private equity and capital markets funds and certain other transactions that we sponsor and manage,” the firm said.
The partnership gives South Carolina the option to either invest directly alongside Apollo in investments, or commit capital to Apollo funds.

As LPs become more comfortable with private equity, they will increasingly look for ways to co-invest with their trusted managers. Those GPs with the creativity to offer such products to their LPs will be able to attract capital, and build relationships, faster than firms without such offerings.