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Returns & diversification behind rise of private equity co-investment funds

By Shanu Sherwani, DELANO (Luxembourg) October 2023

Co-investment funds are gaining traction in private equity due to advantages such as increased diversification, cost-effectiveness and strong performance, writes Shanu Sherwani at AM Investment Management and Antwort Capital in this guest column.

According to S&P data, global private equity deal value has dropped by 51% yearly during the first six months of 2023. Simultaneously, the amount of transactions has decreased by 39%. These bleak numbers point to a challenging environment for the private equity business. Despite this, the co-investment community has shown to be significantly resistant.

Co-investment funds are gaining popularity in private equity and alternative investments. These funds allow limited partners (LPs) to work with general partners (GPs) on specific deals or opportunities, providing various benefits that can improve overall results and reduce risks. In this article, we will look at the primary benefits of co-investment funds and why they are becoming popular among institutional and private investors.

Increased selectivity whilst maintaining diversification benefits

The ability of co-investment funds to provide investors with a curated portfolio of select buy-outs is a crucial advantage. This is especially so when the co-investment fund manager is able to generate a significant funnel of opportunities, from which they may de-select the majority of cases which don’t meet critical risk/reward and portfolio criteria. Nevertheless, it remains important to “spread the bets” and diversify. Best-in-class managers offer co-investment programmes across, say, up to 35 co-investments. This increased diversification, versus a single or only a handful of co-investments, spreads risk across a broader range of businesses, reducing the impact of any single underperforming assets.

Overall, a well diversified co-investment fund provides diversification across industries, geographies, size brackets, vintages and investment techniques, thereby lowering exposure to any specific concentration risks.

Multiple general partners

By diversifying across various GPs, co-investment funds give LPs access to numerous GPs rather than just one, creating another layer of risk mitigation. This reduces the risk associated with a single GP’s idiosyncratic performance, which can substantially skew the entire portfolio.


Co-investment funds frequently have cheaper fees than standard private equity arrangements. Traditional private equity funds typically charge a 2% management fee and a 20% performance fee (2/20), whereas co-investment funds have lower or significantly reduced cost structures. This results in cost reductions for investors, which eventually improves overall returns.

Continuous deployment and market timing

Co-investment funds provide more consistent and predictable deployment. Deals are generated from a large pool of opportunities frequently taken from just closed transactions. This strategy ensures consistent deployment and allows investors to capitalize on opportunities during market downturns when fewer transactions are completed overall.

Performance evidence

Recent academic study has alleviated concerns about the quality of agreements offered as co-investments by GPs. In contrast to previous studies that concentrated on mega-deals from 2006 to 2007, new research reveals that co-investments produce comparable or greater gross returns when compared to the rest of a GP’s portfolio.

Several factors back this conclusion:

– After maximizing their own fund’s appetite and concentration limits, GPs offer co-investment opportunities, indicating a high level of conviction.

– GPs are unlikely to give poor deals to endanger their ties with LPs.

– Poor-quality co-investments from struggling GPs can be detected and avoided.

Returns on investment

Research also emphasizes the significance of portfolio-level results. Because of the skewed distribution of deal-level returns, single co-investments may provide lower returns than the average fund. As a result, the ability to select only the best deals becomes critical. ‘Reasonably sized’ co-investment portfolios, particularly in buyout strategies, often provide greater average net returns, highlighting the importance of co-investment funds in constructing diverse portfolios.

In light of the present environment, with some co-investors exiting amidst liquidity challenges and increased demand from general partners seeking to preserve committed capital, co-investments are as attractive as ever. With dedicated platforms, GPs reach out to loyal co-investors, offering security in an otherwise uncertain climate. Furthermore, some significant US pension funds have moderated their co-investments due to capacity concerns. At the same time, Middle Eastern LPs have increased their efforts, partially filling the gap created by the US pension funds. With fundraising times lengthening and deal equity requirements growing due to restricted finance availability, GPs require co-investment more than ever.

It’s important to acknowledge that raising an average mid-market private equity fund is challenging and likely to remain so for several years. In such a climate, the option to stretch investments by incorporating co-investment is increasingly appealing. A few years ago, investors might have rushed to market without considering co-investment, but today, optimizing capital through co-investment is a strategic choice.

Claus Mansfeldt, chairman of Swancap, a private equity fund and co-investment manager with €4bn in multi-investor funds under management, including the recently announced Swan VI co-investment fund, highlights the strong case for co-investment funds. He cites their benefits, such as increased diversification, cheaper costs, exposure to leading GPs, and empirical evidence of strong performance, as reasons why they are an appealing option for institutional and private investors. He contends that co-investment funds enable institutional and private investors to maximize profits while limiting risks, establishing them as a critical tool in today’s financial landscape.

According to Manuel San Salvador, managing partner at Antwort Capital, a feeder platform focusing on top quartile private equity funds, co-investment is a very interesting strategy to include in private investors’ portfolios. He highlights the importance of incorporating private equity in an overall portfolio composed of liquid assets such as cash and monetary instruments, fixed income and listed equities. Private equity is usually 10% to 15% of a well-diversified portfolio and can add up to 2% annual return to the overall return of the portfolio over a ten-year period. The return of the private equity allocation further enhances with the incorporation of a co-investment fund.

Multimanager funds, which come in the form of funds of funds and co-investment funds, are the best way to gain diverse exposure to private equity. Co-investment is a particularly efficient strategy because it reduces the duplication of fees and accrued interest associated with funds of funds. This enables investors to partner with various managers across, say, 20 to 30 companies, dispersing risk and increasing diversity.

Co-investment faces competition from an unexpected source: the secondary market, namely the rise of continuation vehicles. The rising use of continuation vehicles has sparked debate over the distinction between co-investment and secondary investments. If an asset is new to the GP and does not have prior exposure, it is termed a co-investment; otherwise, it is considered a secondary.

Continuation vehicles are unlikely to disappear from the financial scene. They provide an additional source of liquidity in addition to M&A and IPOs. The fundamental distinction between co-investment and secondaries is economic, as continuation vehicles have fees and carry while co-investments typically do not.

Despite the considerable unrealized value locked up in private equity projects owned by GPs, which has risen to roughly $3trn, continuation vehicles account for only about 5% of exits. It remains to be seen how continuation vehicles affect the desirability of no-fee, no-carry co-investment. However, these vehicles have emerged as a viable choice for both GPs and LPs seeking alternate exit strategies.

Despite the challenges in the private equity sector, deal flow for co-investment remains strong. However, prices have remained high, with relatively minor changes outside the technology sector, particularly in the United States. Selectivity is critical in co-investment transactions, and funds are increasingly focusing on implementing only the most attractive projects proposed by top-tier GPs, even if it means accepting higher multiples.

Because of debt uncertainties and geopolitical tensions, valuations in Europe have shifted considerably. Businesses with a long-term revenue strategy, steady top-line growth, and pricing power fetch the highest prices. Healthcare, critical business services, asset management, insurance brokerage, food and distribution also see high demand and valuations.

Furthermore, demand for infrastructure co-investment has increased, owing to the correlation with inflation and downside protection. Despite the increasing attention, valuation multiples in these industries have mostly stayed the same for the best companies.

Finally, co-investment funds have emerged as a durable and appealing choice in the ever-changing private equity sector. Their ability to increase diversification, reduce expenses, provide exposure to numerous GPs, and provide performance evidence has made them popular among institutional and private investors. While competition from continuation vehicles should be considered, co-investment is still essential for optimizing returns and controlling risks in today’s investment climate. The high values in some industries emphasize the significance of selectivity and due diligence in co-investment decision-making. Despite the hurdles, co-investment funds continue to thrive and evolve, providing investors a viable path in the volatile world of private equity.