Co-investment Surpasses Primary Funds in Private Equity
· deals
Direct Investments Poised to Overtake Primary Funds
The private equity landscape is undergoing a seismic shift driven by investors’ growing desire for control and visibility in their investments. A recent survey of 56 top buyers reveals that co-investment and direct investment strategies are gaining popularity at an unprecedented rate, with nearly three-quarters of respondents expecting combined volumes to break records in the next five years.
This trend is not surprising, given the limitations of traditional fund investing. When committing to a primary fund, investors have limited visibility into the underlying assets and must often rely on general partner recommendations rather than their own due diligence. In contrast, direct investments offer greater control, allowing investors to underwrite specific assets and model their returns with precision.
The survey highlights investors’ willingness to adapt to these changing dynamics. A staggering 78% of respondents expect combined volumes to reach $215 billion this year, up from last year’s record in directs and co-investment. This surge is driven by the increasing availability of data and analytics tools, which enable investors to make more informed decisions about their investments.
A significant majority (73%) of survey respondents are willing to accept variable carry on co-investments, tied to managers meeting certain return thresholds. Directs buyers remain more cautious, with 46% willing to accept variable carry and only 13% prepared to pay more than 20%. This trend suggests a willingness among LPs to experiment with new pricing models.
The European market is notable for its co-investment opportunities driving fundraising activity. As of writing, co-investment funds have raised nearly €6.3 billion this year, close to the €7.2 billion raised in all of last year according to PitchBook data. This growth reflects a broader trend towards more concentrated capital allocation.
The numbers are telling: while the number of co-investment funds has fallen for four consecutive years to just 14 closes, the capital raised by these vehicles continues to climb. The largest co-investment fund to close this year, Pantheon Global Co-investment Opportunities Fund VI, raised $3.2 billion together with its related vehicles.
This shift towards direct investments and co-investments has significant implications for private equity firms. As LPs demand greater control and visibility in their investments, general partners must adapt their strategies to meet these changing expectations. This may involve offering more flexible pricing structures or developing new products that cater specifically to the needs of direct investors.
The impact on fundraising activity is already being felt. Partners Capital Investment Group’s Merlin IV fund closed with over $1 billion in commitments earlier this year, focusing on lower mid-market and mid-market buyouts – an area where co-investment strategies have historically excelled.
As the private equity landscape continues to evolve, one thing is clear: LPs are driving change through their demands for greater control and visibility. While traditional fund investing will undoubtedly remain a significant component of private equity investment, direct investments and co-investments are poised to take center stage in the coming years.
Reader Views
- TCThe Cart Desk · editorial
The co-investment surge is less about investors seeking control and more about their growing impatience with fund managers' underperformance. The fact that 73% of survey respondents are willing to accept variable carry on co-investments suggests they're desperate for returns rather than genuinely interested in flexibility. Meanwhile, the European market's reliance on co-investment funds raises questions about whether this trend is a symptom of underlying market weaknesses or simply a necessary adaptation to shifting investor expectations.
- PRPat R. · frugal living writer
While the trend towards co-investment and direct investment strategies is undoubtedly driven by investors' desire for control and visibility, we shouldn't overlook the elephant in the room: the risks associated with reduced fund sizes. As primary funds shrink in favor of smaller, more bespoke deals, LPs may struggle to achieve economies of scale and diversification, potentially leading to higher fees and lower returns. It's essential that investors weigh these trade-offs carefully before shifting entirely towards direct investments.
- SBSam B. · deal hunter
While direct investments and co-investments gaining traction is a trend worth watching, one thing that jumped out at me in this article is the significant difference in pricing structures between European co-investments and directs. It's concerning that 46% of directs buyers are willing to accept variable carry, which may lead to unclear profit margins down the line. Without standardization in pricing models, LPs risk overpaying for assets and underestimating the true cost of control – a lesson investors would do well to keep in mind as they pursue more direct strategies.