Investor Base: Growing conflict

One of the most significant changes within the limited partner community in recent years has been the increased appetite for co-investments.

However, a desire for better access to co-investments might cause investors to back certain managers for the wrong reasons, according to Soichi Sam Takata, head of private equity at Tokio Marine Asset Management.

“My concern is that because some LPs require co-investments in order to invest in a fund, they will have a selection process that is very different from just investing in a GP that is good,” he explained, while speaking on a panel at Private Equity International’s Asia Forum 2014 in Hong Kong in March.

“Some GPs are too small to offer co-investments because of their team resources or their deal size is too small. So the smaller funds get the short end of the stick and may get less money at the end of the day, even if their performance is good. That is a big concern.”

Wen Tan, a partner at FLAG Squadron Asia also speaking on the panel, further pointed out that co-investments also have the potential to create a conflict of interest between GPs and LPs.

“If the trend continues where there is an increasing amount of direct investment by LPs, there is a question that many in the GP community will have to start thinking about in such cases: what if one of your large investors is also competing with you on transactions?” (This situation has already started to occur in developed markets.)

However, while co-investing can create some thorny issues for LPs and GPs alike, actual co-investment deals continue to be a relatively rare phenomenon both in Asia and globally, the panellists said.

According to Takata, there are just seven LPs globally doing substantial amounts of co-investing, and they are all very large institutions. According to data he cited, the seven have an average of $94 billion in assets under management and around a 15 percent allocation to private equity.

So in practice, conflicts like these are not currently happening very often. But if it becomes the norm, because more LPs are demanding it and more GPs are going out of the way to provide it, there’s a very real danger that LPs could start to find themselves butting horns with their own managers.