The co-investment dilemma

LPs are deterred by the speed that it takes to evaluate opportunities.

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Appetite for co-investment opportunities in private debt has shown signs of cooling in recent years, with fewer than two-thirds of LPs interested in participating in such deals over the next 12 months.

According to Private Debt Investor’s LP Perspectives 2023 Study, only 29 percent of LPs will look at co-investment opportunities in 2023 – a figure that, while up slightly from 2022, is down from a high of 36 percent back in 2020.

Jeff Griffiths, partner and co-head of global private credit at Campbell Lutyens, says: “There is really not a lot of classic co-investment going on in private debt. The only deals taking place tend to involve the largest sophisticated investors that have the capabilities in-house to look at the opportunities and evaluate them quickly – very few investors can do that.”

When asked which factors hinder their participation in co-investing opportunities, 44 percent of LPs said they were put off by the speed required to conclude transactions, a further 37 percent said the ticket sizes required were prohibitive and 33 percent of investors said they were not staffed up to do the deals.

Griffiths says: “There are a growing number of managers setting up co-investment vehicles in response to LP demand, but those tend to be a popular way for investors to get lower fees and are structured in such a way that managers can put what they want into the vehicle without having to deal with an approval process for LPs. Classic co-investment is isolated to a very small group of LPs in private credit.”

Munich-based investor Golding Capital Partners recently held a first close of its debut private debt co-investment fund on €75 million, with a target of €200 million. That vehicle is structured as a Luxembourg fund with an eight-year lifespan and a target return of 7-8 percent net IRR, with deals benefitting from double due diligence conducted by both Golding and partner funds.

Jakob Schramm, partner and head of private credit at Golding, says the vehicle is suitable for both experienced investors looking to expand their private credit allocations, and to those looking for first-time exposure to the asset class. It expects to make between 20 and 25 investments focused on first lien, senior lending in Europe, with four deals already closed.

Says Schramm: “We have an existing infrastructure co-investment programme, and a private equity co-investment programme, so it was obvious for us to think about private credit. We see strong appetite from LPs as this vehicle sits at the lower end of the risk spectrum. A very typical process sees us set up sizeable managed accounts for LPs, and for these portfolios it almost  always makes sense to mix in co-investment exposure. That is a proposition a lot of our LPs really like.”

Schramm believes the market is particularly intriguing currently, as “everybody knows it is potentially a very good time to invest as others pull back. That is why we think the private credit co-investment fund is particularly interesting today, because it moves faster than committing to a primary fund and so there is a chance to get exposure to idiosyncratic opportunities quickly”.

Bobby Molina, managing director and head of origination at Briarcliffe Credit Partners, says he is surprised by the finding that co-investment appetite is weak. “Significant investors in private credit, like the big pension funds, tend to like co-investment opportunities because they are a way for them to dilute the fees they are paying,” he says. “Particularly the management fee can sometimes be diluted to zero. That said, credit co-investment does require proper resources and a certain level of understanding of how to do primary deals. Co-investments are not as active for LPs in private credit as they are in private equity, but we would expect that to change over time as LPs develop more sophistication.”

Molina says GPs are increasingly driven to establish co-investment vehicles because they allow them to do bigger deals and cement their relationships with key LPs that they can work with on an ongoing basis.

There is an expectation that co-investing may become more widespread in private credit, but it is likely to concentrate at the upper end of the market. Griffiths says: “Co-investment is not a really big feature of private credit, and it is focused at the upper end because those large deals are where the managers will most often need partners to split up the ticket sizes. It really is very much a larger-cap phenomenon.”

One in four LPs said they were not doing co-invests because of a lack of opportunities, with 19 percent pointing to a lack of invitations to participate.