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Co-investment Funds

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Co-investment Funds at a glance

Co-investment funds allow institutional investors to invest alongside private equity managers on a deal-by-deal basis. These funds typically offer lower fees and provide access to highly selective transactions. At the same time, partnering with co-investment funds allows GPs to access additional capital for larger deals, strengthen relationships with LPs, gain deal structuring flexibility, accelerate execution, share risk, showcase expertise, and enhance their track record while fostering long-term partnerships.

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Asset class leaders

Churchill Asset Management
PPM America, Inc.
Allianz Global Investors

Why invest in Co-investment Funds

Access to Exclusive Deals: LPs gain exposure to hand-picked, high-quality deals curated by the GP, without having to source them independently.

Diversification: Co-investment funds typically invest across multiple deals, providing LPs with diversification within the fund structure.

Lower Fee Structure: Co-investment funds often offer more favorable fee arrangements compared to traditional private equity funds.

Efficient Capital Deployment: LPs can deploy capital into multiple co-investments through a single vehicle, streamlining the investment process.

Alignment with GP: The co-investment fund structure ensures close alignment with the GP's interests, as they invest alongside LPs in selected deals.

What are the main risks of Co-investment Funds

Concentration Risk: Co-investment funds may focus on fewer deals compared to traditional funds, increasing exposure to individual investments and sectors.

Deal Selection Bias: GPs may offer co-investment opportunities that don’t align with their core fund’s strategy, potentially pushing riskier or less desirable deals to co-investment vehicles.

Limited Time for Due Diligence: Co-investments often require quick decision-making, which can limit the time available for thorough due diligence and increase the risk of poor investment choices.

Market Timing Risk: Since co-investments often happen during periods of market opportunity or specific deal flow, LPs may be exposed to higher risks if the timing of the investments aligns poorly with market cycles.

What characterizes Co-investment Funds?

Industry/Sector: Co-investment funds typically focus on specific sectors or industries aligned with the GP’s expertise and strategy. While some co-investment funds are sector-agnostic, many target high-growth industries like technology, healthcare, industrials, or consumer goods, depending on the GP’s deal flow and investor preferences.

ESG: Environmental, Social, and Governance (ESG) considerations are increasingly important in co-investment funds. Many funds incorporate ESG criteria to ensure investments align with sustainable practices and responsible governance. Co-investments may focus on companies with strong ESG profiles or aim to improve ESG metrics as part of their value creation strategy.

Instruments: Co-investment funds primarily invest in equity instruments, typically in private companies alongside a lead GP. They may also use mezzanine financing or other hybrid instruments depending on the deal structure. These investments are usually direct equity stakes in the target companies, providing exposure to specific deals.

Target Company Size: Co-investment funds often focus on mid-market to large-cap companies. These companies tend to offer robust growth potential, established market positions, and the ability to absorb significant capital. However, some funds may target smaller companies if they present unique investment opportunities.

Geography: Co-investment funds typically follow a global or regional investment strategy, often focused on North America, Europe, and Asia. The geographical focus depends on the GP’s network, expertise, and deal-sourcing capabilities. Some funds might concentrate on emerging markets for higher growth prospects, while others focus on more stable, developed markets.

Manager Q&A

Question 1. What do you see as the primary advantages of co-investment strategies for investors?

 

Allianz Capital Partners

In a nutshell, co-investments provide the opportunity to build up highly diversified Private Equity (PE) exposure at a lower cost compared to investments in traditional primary funds. Co-investments offer a distinct advantage in terms of cost structure: Traditional PE funds often come with a “2 and 20” fee model—2% annual management fee and 20% performance carry—while co-investments are offered without these fees for certain investors. This reduction in expenses is especially beneficial in the early stages of an investment when traditional funds may struggle to deliver meaningful returns due to fees. The “no fee, no carry” structure directly impacts performance by reducing the drag on returns, leading to a faster mitigation of the J-curve effect. By lowering costs, co-investments allow investors to see positive returns earlier, enhancing long-term performance.

 

Another critical advantage of co-investments is the potential for enhanced portfolio diversification. Co-investment funds usually contain a higher number of individual investments than traditional PE funds, helping investors spread their risk across different industries, geographies, and sectors. This broader diversification helps mitigate downside risk, as poor performance in one or two investments is less likely to have a disproportionate impact on the overall portfolio.

 

Furthermore, co-investment opportunities are often only accessible through close relationships with experienced fund managers. These deals are highly curated, meaning that investors are likely to participate in opportunities that have undergone rigorous due diligence. Investing alongside seasoned fund managers enables investors to benefit from their expertise and network, accessing top-tier deals that might otherwise be out of reach. This partnership approach enhances the quality of investment selection and execution, leading to higher potential returns.

 

 

Churchill Asset Management

Co-investment remains popular amongst LPs as the asset class has matured and grown over the past decade. Co-investment has become an increasingly utilized tool, with LPs attracted to the potential for outperformance, lower fees, increased selectivity and thoughtful portfolio construction.

 

- Potential for higher returns when compared to traditional private equity fund investments. According to Preqin data, co-investments have historically outperformed direct private equity. Additionally, there is a large return premium driven by larger value creation opportunities due to investing alongside top-quality sponsors in selected deals.

 

- Attractive economics relative to private equity fund commitments. In the case of Churchill Co-investment II, the management fee is 1% on invested capital and a 10% carried interest1 (as compared to the prototypical 2% management fee on committed and 20% carried interest for a primary commitment). These highly favorable economics not only drives portfolio outperformance but also improves J-curve mitigation.

 

- Increased selectivity when participating in equity co-investments. Investment screening is done by both sponsors and Churchill’s independent underwriting. Churchill also benefits from an information advantage stemming from its’ deep relationships with sponsors, exemplified by the firm’s 245+ advisory board seats.

 

- Thoughtful portfolio construction through Churchill’s proactive approach to sectors, valuation, and leverage. Co-investment funds seek to create a diversified portfolio built to perform across market cycles.

 

In summary, co-investment funds offer investors access to a diversified portfolio across both sponsors & portfolio companies at lower management fees and carried interest than a traditional private equity fund, while offering investors higher potential returns than fund investments through a superior pipeline of assets to select from.

 

 

2. How do you approach deal selection for co-investment opportunities?

 

Churchill Asset Management

Co-investment deal volume has experienced strong momentum and continues to scale. Churchill has a large funnel of deal flow sourced from its $11+ billion primaries portfolio of 310+ funds2, and receives “early looks” on 90% of co-investments given Churchill’s ability to underwrite side-by-side with GPs3. By offering GPs a solution to get deals done, Churchill minimizes the risk of adverse selecting, transacting on 10-15% of investments per annum.

 

Churchill pursues a disciplined and deliberate process that aims to be highly selective while moving quickly to meet the needs of our GPs. Churchill has defined target investment criteria, which enables for efficient screening and a quick initial assessment of areas that may require deeper due diligence. We believe speed is crucial to Churchill’s position as a preferred co-investment partner, and Churchill’s process is designed to evaluate and underwrite co-investments in as little as two weeks. The average underwriting process takes three to six weeks.

 

Co-investment deal review is discussed at a weekly pipeline meeting during which deal memos are presented to the full investment team of 31 professionals. Weekly pipeline meetings encourage a robust dialogue by all team members, where insights, learnings and perspectives are actively sought from the group.

 

Churchill views the co-investment process as consisting of five distinct phases: (1) Initial Vetting & Structuring, (2) Early Assessment, (3) Full Due Diligence, (4) Final Investment Committee, and (5) Closing. Throughout the investment process, the investment team applies a thorough, consistent and disciplined approach to evaluation. At any stage the investment may be declined.

 

With respect to staffing, Churchill believes that taking a sponsor-centric approach is key to cultivating deep relationships. Each private equity firm is covered by a dedicated team throughout the relationship’s lifecycle, from LP fund commitments to direct co-investments and junior capital investments. Having one touchpoint across multiple capital types provides a level of user friendliness that sponsors appreciate and gravitate towards when choosing co-invest partners.

 

 

Allianz Capital Partners

Our approach is based on the following four pillars. First, we put emphasis on a compelling deal setting. This involves co-investing only with the leading / high-conviction fund managers from our portfolio of primary funds, with which we have a longstanding relationship and who have successfully demonstrated a successful track record. Furthermore, we co-invest only in the sweet spot of the manager’s strategy (their area of expertise, not what they would like to explore). Moreover, we require a long history and good knowledge of the asset by the fund manager.

 

The second pillar is a clear path to value creation which includes multiple ways of winning (e.g. different exit route options) and mitigating of any unforeseen headwinds, seeking to avoid single “bets”. The focus on a leading and sustainable business model is the third pillar of our strategy. The target company must exhibit the following characteristics: First-class management team with experience in the industry and in that company across cycles, strong industry position with reasonable entry barriers and attractive company & industry economics.

 

The fourth pillar are our requirements regarding the capital structure: we expect a reasonable entry valuation and exit assumptions, in absolute levels and relative to long-term valuation levels as well as adequate and sustainable leverage at entry and tailored to the cash-flow profile. Additionally, we follow an extensive set of ESG related exclusions & guidelines and focus on intelligent portfolio diversification to avoid concentration risks in the portfolio.

 

 

3. What trends are shaping the co-investment landscape today?

 

Allianz Capital Partners

We believe that co-Investments are particularly attractive in the current difficult market environment, providing the potential for unique entry points and enhanced returns due to the attractive fee structure. Fund managers have to increasingly rely on co-investment partners: As debt has become more expensive, GPs need to invest higher equity amounts leading to increased reliance on co-investment partners (with some of industry players being less active/leaving the market due to capital constraints). Co-investments can also be a good option for general partners (GPs) facing a challenging fundraising environment, allowing to bridge the gap until fundraising activity recovers.

This often leads to constant high quality deal flow from which one can choose attractive opportunities, otherwise not easily accessible: Portfolio adjustments and tougher market for fundraising offer unique entry points and provide an opportunity to enhance returns without the drag of fees. Furthermore, in the current volatile and uncertain market environment, co-investments allow to be more selective in picking companies/ sectors with high expected performance, rather than being locked into a predetermined strategy. Last but not least, the right network to the right fund managers to get access to these co-investment opportunities, remains crucial.

 

Churchill Asset Management

Looking ahead, Churchill is excited about the opportunity set for the co-investment asset class, particularly in the U.S. middle market. Churchill has a long history of partnering with top-tier GPs, who have demonstrated track records of driving fundamental value creation throughout market cycles.

 

Attractive valuations

Valuations remain strong for high quality assets, driving U.S. middle market multiples back to ~12x in 1H24, compared to ~11x in 1H23 per Refinitiv data. More conservative debt structures will likely increase demand for equity co-investment to complete transactions.

 

Favorable co-investment supply dynamics

After putting many sale plans on hold for a lengthy period, GPs are highly motivated to pursue more exits in view of fundraising objectives and low distribution activity. In a fierce fundraising environment, GPs will seek increased co-investment equity in order to achieve desired fund holds.

 

Longstanding return premium in the middle market

Compared to the upper market, the middle market has more value creation opportunities and more flexible exit routes (i.e., less reliance on public market exits), which has encouraged resiliency during market downturns. According to Preqin data, the middle market buyout index experienced a less severe trough and a higher peak during the GFC and in the subsequent years than its large and mega cap counterparts.

 

Large addressable market

Over 200,000 companies reside in the middle market, and with over $6 trillion in revenues, the US middle market would be the third largest economy in the world when measured by GDP (after the US and China)4. The middle market is rich in high quality businesses with growth potential, making it an attractive market for Churchill, whose investment thesis has always been based upon investing in non-cyclical sectors with strong free cash flows and business models.

 

Overall, the opportunity set with co-investments, specifically within the middle market, remains robust. Increased certainty of macro conditions, subsiding inflationary pressures, and cheaper cost of capital are expected to drive an increase in middle market deal activity. Churchill will continue to target growth-oriented platforms with abundant value creation opportunities that are leaders in growing niche end markets in sectors that have attractive long-term fundamentals.

 

 

 

Churchill Asset Management notes:

Opinions and views expressed reflect the current opinions and views of Churchill as of the date of this material only. Nothing contained herein is intended as a prediction of how any financial markets will perform in the future and nothing contained herein should be relied upon as a promise or representation as to past or future performance of a fund or any other entity, transaction, or investment.

 

1 The carried interest increases to 12.5% if Churchill Co-Investment II achieves a net MOIC of 2.0x or greater.

2 Includes private equity fund commitments made under the Private Equity fund strategy since 2011. Excludes venture capital and secondaries commitments. TIAA and client capital commitments to Churchill that are not yet committed to specific underlying funds are excluded. Since 2011, as of 30 Jun 2024.

3 Over the course of 2021 and 2022.

4 Source: World Bank Open Data Database as of 31 Dec 2022; Middle Market assumption based on the definition by National Center for the Middle Market as of 31 Dec 2023

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