Are Co-investments Attractive in Today’s Environment?

Yes. We believe co-investments are an attractive opportunity in the current market for three primary reasons. First, the challenging fundraising environment has increased the incentive for general partners (GPs) to offer co-investments. Second, in a slow-paced environment, the ability to control capital deployment is increasingly valuable for limited partners (LPs). Third, a co-investment offered today should have current market dynamics factored into its underwriting, providing LPs with confidence that valuation, return expectations, and deal structure are based on prudent—even conservative—assumptions.

We believe success in co-investing is driven by access to robust and high-quality deal flow, and the current market climate creates additional incentives for GPs to expand their co-investment offerings. Private fundraising ¹ activity slowed in 2022 and 2023, with respective declines of ~21% and ~35% from its peak in 2021. Though 2024 fundraising data show early signs of recovery, private markets have also underperformed public markets in the short term. The continuing distribution drought has led to skepticism among some LPs about the benefits of private investments, which in our experience has created a dynamic whereby GPs have to work very hard to secure fund commitments.

Co-investments play an increasingly important role in today’s fragile environment for two reasons. First, providing co-investment opportunities allows GPs to build goodwill and showcase their expertise to current and prospective LPs. Second, GPs can use co-investments to make their current fund capital go further. Due to the added incentives for GPs, LPs should benefit from improved access to high-quality opportunities, resulting in a more robust funnel. However, the co-investment evaluation process is critical; LPs must remain wary of adverse selection.

Co-investments offer LPs an important tool to control pacing and express market views. While this is true in any investment environment, it is particularly valuable when private market activity slows. In 2023, global private equity capital deployment was down ~46% from its peak in 2021, and in 2024 it is tracking to a ~43% decline from the historic high. ² Despite this slowdown, GPs are increasingly incentivized to offer co-investments as discussed above. LPs can leverage this co-investment deal flow sourced across GP relationships to manage investment pacing. Further, compared to blind-pool funds, co-investments allow LPs to control specific exposures—and associated risks—in a portfolio. This enables LPs to focus on opportunities that are attractive in the current environment, which can help be identified through the due diligence process. Acknowledging that market volatility has led to allocation constraints for some investors, co-investing can still be a useful tool. Those with direct co-investment programs can adjust annual budgets to respond to market swings, while LPs using co-investment funds can continue to benefit from them by scaling back other commitments.

Co-investments are underwritten based on the current market environment, and today’s landscape should foster more conservative assumptions. Private equity firms synthesize macro and microeconomic data from public and private markets to inform their assumptions that drive financial forecasts and return projections. Typically, GPs provide detailed information about their underwriting to co-investors that can then validate these assumptions as part of their own due diligence process. These factors include, but are not limited to, company valuations, market growth rates, industry dynamics, and the availability and cost of debt. Recently, valuations have fallen from 2021 highs, growth forecasts are more conservative, and higher debt costs have focused sponsors on appropriate capital structures. The confluence of these factors should provide LPs with confidence that the current opportunity set is based on prudent underwriting assumptions. We believe deals struck in this vintage could produce attractive returns in the long run.

While co-investments offer high potential to add value, they are complex to source and execute. Co-investors should have a sound strategy and understanding of where they can be most competitive in finding the greatest value. We believe success is driven by a robust pipeline of opportunities and by having the appropriate resources to be able to transact quickly and efficiently. Today’s market has shifted the incentives of GPs to provide quality co-investment opportunities to LPs, for whom the ability to control capital deployment is increasingly valuable. In response to higher interest rates and a challenging fundraising market, underwriting standards have risen. Co-investors can evaluate these underwriting assumptions and build conviction in today’s opportunity set. Co-investing is a critical component of the private investment ecosystem and one that is particularly attractive today for those that are well positioned and prepared.

Rob Long, Senior Investment Director, Private Equity

Footnotes

1. Private fundraising refers to buyout and growth equity funds.
2. The 2024 fundraising activity is annualized based on data as of March 31, 2024.