The co-investment craze

Just over half of investors in infrastructure funds plan to participate in co-investment opportunities over the next 12 months, according to Infrastructure Investor’s LP Perspectives 2022 Study – slightly up on the 47 percent recorded a year ago. “We see appetite from institutions across a wide range of different geographies, sizes and types, as investor sophistication grows across the asset class,” says Jessica Kennedy, director responsible for investor relations at Northleaf Capital Partners. “This is still a relatively new industry, but the evolution of co-investment is mirroring the evolution of the broader infrastructure market.”

Kennedy adds that there are geographical differences in the level of co-investment appetite. She cites particular interest from mid-sized Canadian institutional investors, which are following the lead of their larger, direct investing peers.

“Generally speaking, though, we see demand for co-investment across most OECD countries, among mid-sized institutions and upwards,” Kennedy adds. “These are investors that have built an internal team, have already made a number of fund investments and have some co-invest experience under their belt. They trust their managers and are starting to double down on opportunities through a co-investment programme alongside those GPs.”

Tavneet Bakshi, global head of due diligence at FIRSTavenue, agrees. “Interest in co-investment is only moving in one direction,” she says. “We are seeing a significant increase in appetite across LP types.”

“Co-investment appetite is definitely growing,” agrees Brent Burnett, co-head of real assets at Hamilton Lane. “GPs that have demonstrated a commitment to offering co-investment to interested LPs have been more successful in raising capital. LPs view co-investment as an opportunity to scale up exposure to GPs and sectors they like, usually with preferential fee terms.”

The opportunity to average down fees is undoubtedly a key driver of co-investment, which is typically offered at a zero-fee rate for an amount equivalent to an LP’s commitment to the main fund. Investors are also using co-investment to help reach specific portfolio construction goals, according to Kennedy.

“It could be that an investor is underexposed to a particular geography in its fund portfolio, or perhaps underexposed to a certain subsector,” she says. “That investor will then look to co-investment opportunities to achieve its optimum portfolio construction and to right-size any exposure mismatches.” In particular, Kennedy suggests investors are looking to increase their exposure to renewable energy investments in order to reach ESG goals.

Bruce Chapman, founder of Threadmark, says the most notable recent increase in appetite for co-investment comes from asset managers and fund of funds players. “We see those groups enhancing their offering to their underlying investors with the addition of co-investment,” he says. “That is a valid evolution, as these firms often have sizeable teams and can act quickly when required. They know what risks they are willing and not willing to take and so can be efficient in deciding what they will and won’t pursue.”

Challenges remain

Co-investment appetite and co-investment ability are not always the same. Insufficient resources were deemed to be the biggest obstacle to co-investment, according to survey participants, followed by a lack of available opportunities. Tight transaction timetables were also cited as a challenge.

“While many LPs express an interest in co-investment, few are set up to execute,” says Burnett. “Co-investments typically move quickly and LPs need to have dedicated teams and efficient approval processes in order to participate on a timeline that works for the GP. Most LPs, especially in the US, are not set up to do this.”

“It is important that investors are well equipped and able to move quickly,” adds Kennedy. “A co-investment might need to be executed in anywhere between four and 12 weeks, even in a post-deal syndication. Investors therefore need to be nimble and able to manage their approval processes quickly.”

Good communication is also key. “It is helpful for co-investors to keep us up-to-date as they work their way through their due diligence and approval processes,” says Kennedy. “Having open and honest dialogue is absolutely critical.”

Bakshi, meanwhile, adds that many investors are circumnavigating the challenges associated with co-investment by handing over the responsibility for selection and execution to the GP. “A growing number of closings now include discretionary co-investment vehicles,” she says. “The GP makes the decision about which co-invests to execute, which means the LP can blend down their average costs without having to invest in the level of resource or governance framework required to deliver on a full co-investment programme.”