With limited partners increasingly hungry for co-investments, having a strong relationship with general partners is paramount to stand out from the competition. Funds of funds have such connections in spades and could be uniquely positioned to leverage their position between LP and general partner as an outsourced co-investment or directs consultant.
Hermes GPE, a UK-headquartered fund of funds, has already made the transition. The firm is currently investing its third co-investment club fund, a $389 million 2015-vintage, with commitments from LPs including Ardian, State Teachers Retirement System of Ohio and Canada Pension Plan Investment Board.
“What we saw a few years ago was people with primaries programmes that wanted to get more exposure to co-investing,” partner Elias Korosis tells Private Equity International.
“We said, ‘Why not bring these LPs together into one structure where we act as the central co-investment engine, co-ordinating and transacting dealflow contributed by everyone?’ It’s very much a core part of how we’ve developed the business.”
The Hermes co-investment programme operates on a goodwill basis and LPs have no legal obligation to share their dealflow with the pool. Hermes has complete discretion in which co-investments are pursued and will perform due diligence on each deal.
“We’ll work with your preferred GPs as you wish and we’re not going to try to disintermediate that relationship as a traditional fund of funds,” Korosis says.
“There are models where the LP stays connected through the process, but we’re clear that we’re running the investment selection. That’s quite important for the GP not to have to deal with various layers of board approvals.”
Co-investments are top of mind for a majority of LPs, with nearly two-thirds planning to invest in such opportunities, according to the PEI LP Perspectives survey 2019. However, a third said a lack of staffing was hindering their participation.
Choose your exposure
Funds of funds managers can also tap this demand without a dedicated co-investment vehicle. Luxembourg-headquartered Quilvest Private Equity, which has around $5 billion of assets under management across direct vehicles, separately managed accounts and funds of funds, does so from its flagship vehicles.
The firm’s clients can decide their exposure to fund commitments and co-investments, and typically opt for a 60:40 split. It has completed nearly 100 co-investments since 2002.
“The vast majority of our co-investments are with GPs in our fund portfolio and we’ll do some with GPs that could qualify to be in our next fund,” says partner Jean-François Le Ruyet. “We tend to be a bit cautious about opportunities coming from funds that are not in our portfolio, because we ask why the LPs in those funds have not themselves chosen to co-invest.”
The firm serves as a form of co-investment consultant to certain clients by presenting co-investment tickets that might be too large for its flagship fund to SMAs with capacity to write bigger cheques. Doing so carries several benefits for Quilvest.
“The client might take a piece and we might take some of the overflow,” Le Ruyet says. “We have two incentives to offer this service: either a piece of the overflow or potentially charging economics on the co-investment.”