Is co-investment a step too far?

Our latest survey suggests private debt investors are keen to avoid overconcentration in their portfolios.

It doesn’t seem too far-fetched to imagine that, when it gets its new private debt strategy fully up and running, Australia’s QIC may well offer its investors a co-investment option. After all, when Andrew Jones, the firm’s newly appointed head of private debt, held the equivalent role at AMP Capital, he oversaw the $4 billion fundraise for AMP Capital Infrastructure Debt Fund IV.

Not only was it reportedly the largest ever fundraise for an infrastructure mezzanine debt strategy, it also boasted $1 billion in co-investment rights. If Jones makes co-investing a central feature of QIC’s approach, it would be no surprise – but equally, in the world of private debt, it would be increasingly unusual.

According to our soon-to-be-published LP Perspectives Study 2021, fewer than one in four LPs expect to participate in co-investment opportunities over the next 12 months, a significant reduction on the equivalent figure this time last year. At the start of 2020, co-investments were emerging as an increasingly popular method for investors to reduce fees and maximise returns, with 36 percent of LPs at that time expecting to participate in deals alongside familiar managers during the year.

Such opportunities may offer fee savings, in addition to the chance for LPs to double-up on their favourite managers, sectors and geographies. Yet some of the shine has gone off co-investments in the credit world during the pandemic. Today, just 23 percent of the LPs surveyed expect to participate in co-investments in private debt, compared with the 71 percent who expect to do so in private equity.

So what explains this discrepancy? We hear from many market sources that co-investment is easier said than done, with the most commonly cited inhibitors including insufficient staffing and challenges in meeting required transaction deadlines. One in four LPs in our study say they lacked sufficient staff, while 34 percent admit they struggled to move quickly enough.

“Competition for the best opportunities and the ability to execute in a reasonable timeframe continue to be the major obstacles,” suggests Andrew Beaton, senior managing director on the co-investment team at Capital Dynamics. “Some investors also lack the investment experience and expertise to tackle co-investment.”

Co-investment can also lead to potentially troublesome concentration issues. Diversification is a prime motive for many investors in private debt, with exposure to potentially hundreds of loans within a given portfolio. Taking large single-company bets doesn’t necessarily sit easily with what many LPs are looking for from the asset class.

It could also be that the challenges of remote due diligence during the pandemic have made investors less willing to take chances, or do anything outside the scope of what they would do normally. Indications from our 2020 fundraising data that senior debt is increasing its share of private debt capital raising is certainly indicative of a safety-first mindset.

Perhaps investors have concluded that, if they’re to continue doing co-investments, it would be better to trust their more longstanding relationships with private equity firms rather than their newer ones with private debt managers. It could also be that, in a year’s time, co-investing will be back on the agenda, and that the current low take-up will be viewed with puzzlement.

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