Co-investments in Private Equity Rise Along With Risks

More pension plans and other limited partners are pairing with private-equity firms to do deals, after a record portion of funds offered co-investment opportunities last year.


Pension plans are becoming more deeply entrenched in private equity by increasingly co-investing in deals done by buyout firms.

Forty-two percent of so-called limited partners — the investors in private-equity funds that include pension plans and sovereign wealth funds — are directly co-investing in private-equity deals, while a further 12 percent would consider doing so, according to data provider Preqin. Their interest has picked up as more fund managers than ever are offering co-investment opportunities, according to Preqin, which said a record 58 percent of those it surveyed in 2016 gave limited partners the option to invest directly alongside them.

“When co-investments go right, they can amplify returns for limited partners, especially because they often include no fees and no carries,” Andrea Auerbach, a Cambridge Associates managing director, said in a phone interview. “The average growth to net between what a manager might earn and what you earn, that difference can be 700 basis points. You get an extra 700 basis points if you co-invest.”

Carried interest is the profit cut that private-equity firms take from their funds’ investments. While avoiding fees and carried interest by investing directly in private-equity deals can be more lucrative for pension plans and other limited partners, they don’t always go as planned, and a maturing bull market could be bad news for outperforming co-investments.

“We’ve been in a strong bull market for years, so most co-investments are going well,” David Fann, chief executive officer at alternative investment advisory firm TorreyCove, said by phone. “What happens to co-investments and private equity in a down market?”

The prospect of falling returns after the bull market reaches its peak hasn’t stopped the strategy from becoming more common among pension funds and wealth managers, according to Fann. He said that buyout deal multiples are now hovering near 10 times Ebitda, earnings before interest, taxes, depreciation and amortization, a level that could fall should things start to go wrong in the stock market. The lower deal valuations could hurt investors’ returns.

There are more complicated ways that co-investments may run into trouble.

Take, for example, KKR & Co.’s 2014 acquisition of Aceco, a Brazilian data-center operator. Singapore’s global investment firm GIC and the Teacher Retirement System of Texas acted as co-investors in the deal, which has become embroiled in allegations of fraud. The Wall Street Journal reported last week that Aceco’s books may have been manipulated since 2012 and quoted a KKR spokesperson saying the firm’s investors had been “defrauded” in the sale of Aceco. KKR fired Aceco’s CEO in late 2015 and last year marked its equity investment in Aceco down to zero, the Wall Street Journal said, citing people familiar with the decision.

Spokespeople for Teachers Retirement of Texas, GIC, KKR, Barclays and Aceco, didn’t return phone calls seeking comment.

While Preqin data show limited partners are benefiting from higher internal rates of returns as result of their co-investment vehicles, TorreyCove’s Fann isn’t alone in his skepticism about how the trend may unfold.

“Co-investment is something that the jury is still out on,” said Antoine Drean, founder and CEO Palico, a firm that helps match private-equity firms with limited partners. “It may not perform as well as some of the LPs are hoping.”