August 2019
Past performance is not necessarily indicative of future results. No assurance can be given that any investment will achieve its given objectives or avoid losses. Unless apparent from context, all statements herein represent GCM Grosvenor’s opinion.
Select risks include: macroeconomic risk, sourcing risk, investment selection, portfolio diversification, management risk, execution of value creation plan, risks related to reliance on third parties, and risks related to the sale of investments.
The private equity co-investment marketplace is growing and maturing, following trends in private equity overall, with more participants from both the capital supply (limited partner) and demand (sponsor) sides. Given the increasing size and evolution of this market, limited partners (LPs) have more ways to participate directly in transactions. With the right sourcing capabilities, LPs now have a wider range of choices for specific transactions and more access to sponsors to partner with on these deals.
We believe the maturing private equity co-investment marketplace is a good thing, on balance. Here, we offer our perspective on the changing opportunity set and investigate the benefits the maturing market offers us as co-investors. In an environment with more choice, selectivity arguably plays more of a role than in a market at a more nascent stage. And as we will discuss, manager research and selectivity is just as critical a part of this process as deal diligence.
The private equity co-investment landscape, much like the overall private equity ecosystem, is indisputably growing. In earlier days, co-investing was a one-off decision to bridge sponsor capital limits in specific circumstances. Now, sponsors have come to embrace co-investment capital as another financing source that they can tap when necessary. The arrangement is beneficial to all participants – to the private equity sponsors looking to secure additional equity financing for deals while furthering their relationship with LPs, and to the co-investors who benefit from strong investment opportunities at favorable economics.|
Indeed, assets in completed co-investment deals have grown steadily. At the end of 2017, capital invested in co-investments was estimated at $60 billion and comprised about 20% of the private equity market, according to Cambridge Associates.1 At GCM Grosvenor, we have committed $3.4 billion of capital across approximately 150 buyout co-investments in the last 15 years.2
Fundraising volumes in recent years also demonstrate the growth of private equity co-investing, as the chart below shows. Along the way, the marketplace is also segmenting. Today there are niche co-investment pools for deal size, industry and growth stage.
The supply of capital is clearly one key driver of the increased activity. Institutional investors, on the whole, are aiming to allocate more to private equity as an asset class. Co-investing allows LPs to commit more capital alongside preferred sponsors and create targeted direct deal exposures for their portfolios. Additionally, the more appealing fee structure of co-investments, which often have no management fee or carried interest, is fueling demand from institutional investors.
By using co-investment in deals, sponsors benefit from the ability to retain control of a transaction, both pre- and post-closing. The wave of club deals in the years leading up to the 2009 financial crisis illustrated some of the difficulties that sponsors encountered when investing together in the same asset. Co-investors also benefit from a maturing co-investment market in a number of ways, including the following:
We believe co-investing with the right sponsors offers the same alpha potential as picking the right funds, from the LP’s perspective. For the past 20 years of private equity investing, upper-quartile managers have outperformed median managers by 820 basis points, according to Burgiss, thus illustrating the critical role manager selection can play in co-investing as well.
As the private equity co-investment market matures, it also offers more continuity. Today, our existing relationships with traditional sponsors (i.e., private equity managers who have a primary fund in which we are an LP) are the biggest source of co-investment opportunities and completed deals. In these relationships, we have the benefit of prior due diligence and a track record to the relationship, which allow us to keep our assessment of the sponsor – of their judgment, management style, and success – up-to-date and accurate. The sponsor also benefits from this continuity, as they can trust that co-investment partners have an established and transparent process for deal decisions, driving shared expectations.
But to source as broad a funnel of deals as possible and try to capture the most alpha, we have to be open to executing co-investments not just with traditional sponsors, but with emerging managers and fundless sponsors as well. As the chart below illustrates, emerging managers are a growing share of the private equity market over the last decade.
Co-investing depends on trust, by design; co-investors have less control over portfolio companies than a traditional private equity investor would have. They tend to be minority investors, for instance, and they’re often the “taker” of deal terms. Manager research is therefore imperative. In our view, investors must be able to accurately assess the skill of their partners based on prior track records, deal experience, or whatever else they know of the manager’s judgment and access to promising opportunities.
Manager research and deal diligence are related endeavors, but the nature of the interaction depends on the manager type:
The maturing private equity co-investment market alters the dynamics of deals in some ways, but overall, these changes represent improvements for both sponsors and LPs. There are more ways for sponsors to utilize co-investors to get deals done, and more opportunities for LPs to participate in single-deal transactions to complement their primary fund investment strategies.
To operate successfully amid growing competition, we believe co-investors must have broad access to deals, and selection is a matter of both manager quality and individual deal potential. Diligence on both fronts is imperative. This philosophy positions private equity co-investors for continued success even in a more competitive environment.
We explore two segments of the market in which we believe there is a particular opportunity to “have your cake and eat it too” by both buying at an attractive entry price as well as partnering with the right sponsor to drive value creation. These two segments are family-owned businesses and public-to-private transactions.
Here we spotlight three market trends that are currently creating opportunities in private credit and examine certain execution challenges that have precluded many investors from implementing credit co-investments. We also discuss why we believe GCM Grosvenor is well-suited to mitigate these challenges and deliver the benefits of private credit co-investing to our clients, in ways that suit them best.
We address some of our clients’ most-often asked questions regarding buyout transactions and whether or not co-investing is the right approach given the current market environment.
Select risks of co-investing include: macroeconomic risk, capital markets risk, credit risk, company risk, and liquidity risk. Additional risks that result in losses may be present.
Additional Notes
1. “Ready, Steady, Co-Invest,” Cambridge Associates, 2019.
2. As of March 31, 2019.
Important Disclosures
Burgiss Benchmark Data – Benchmark is obtained from The Burgiss Group, an independent subscription-based data provider, which calculates and publishes quarterly performance information from cash flows and valuations collected from of a sample of private equity firms worldwide. The performance of GCM Grosvenor’s underlying investments is compared to that of its peers by asset type, geography and vintage year as of the applicable valuation date. Benchmarks for certain investment types may not be available. GCM Grosvenor uploads data into our system one-time each quarter; however, the data service may continue to update its benchmarks thereafter. Therefore, benchmark information in GCM Grosvenor’s system may not always agree with the most current information available from the data service. Investments may be held indirectly through special purpose vehicles.
Investments in alternatives are speculative and involve substantial risk, including strategy risks, manager risks, market risks, and structural/operational risks, and may result in the possible loss of your entire investment. Past performance is not necessarily indicative of future results.The views expressed are for informational purposes only and are not intended to serve as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell securities by GCM Grosvenor. All expressions of opinion are subject to change without notice in reaction to shifting market, economic, or political conditions. The investment strategies mentioned are not personalized to your financial circumstances or investment objectives, and differences in account size, the timing of transactions and market conditions prevailing at the time of investment may lead to different results. Certain information included herein may have been provided by parties not affiliated with GCM Grosvenor. GCM Grosvenor has not independently verified such information and makes no representation or warranty as to its accuracy or completeness. GCM Grosvenor’s strategy definitions differ from those used by The Burgiss Group (“Burgiss”). GCM Grosvenor has used its best efforts to match each strategy with the appropriate Burgiss strategy but material differences may exist. Additional information is available upon request.
We offer clients a broad range of tailored solutions across strategies, including multi-strategy, macro, relative value, long/short equity, quantitative strategies, and opportunistic credit. Levaraging our large scale and presence in the industry, we are able to offer clients preferntial exposure to hard-to-access managers and seek to obtain terms that can drive economic and structural advantages.
