The je ne sais quoi of certain LPs that makes them attractive co-investors

LP demand for co-investment opportunities has risen sharply in recent years and is expected to remain strong this year.

There’s an elusive quality some GPs look for when considering LPs for co-investments. Along with the well-understood ability to transact quickly, GPs also need a partner who is willing to plunge into an investment with incomplete information.

That’s according to Hunter Carpenter, partner at RedBird Capital, who spoke on a panel at EisnerAmper’s Alternative Investment Summit Thursday.

“Being comfortable only having 80 percent of something, to me that’s the biggest difference” between allocators and direct investors, Carpenter said. Investors have to be comfortable “working on a deal on a compressed timeline with pressure where, frankly, you don’t know the answer, because if you knew the answer, you would be seeing into the future.”

Carpenter was in a discussion about the rising appetite among LPs for access to co-investing. LP demand for co-investment opportunities has risen sharply in recent years and is expected to remain strong this year. Private Equity International’s LP Perspectives 2021 Study found 71 percent of LPs plan to participate directly in deals alongside managers in the next 12 months to achieve fee savings and other benefits.

Covid-19 appears to have added to the opportunity set. In a more challenging fundraising environment, some PE firms conserved dry powder, creating the need to turn to co-investment to pad out equity checks, Buyouts previously reported.

Another member of the panel, Steve Nelson, CEO of the Institutional Limited Partners Association, said LPs want access to co-investments to boost performance at lower cost. GPs have traditionally offered co-investment to LPs on a no-fee, no-carried interest basis.

“The appetite for co-investment opportunities from LPs remains very strong, it has not been dented at all by the past year and a half,” Nelson said.

The challenge for LPs is to develop their investment teams in a way to provide for expertise around direct investing, Nelson said. This could also mean that, for some institutions, they have to adjust their governance structures to allow for quick approvals or perhaps limited due diligence of opportunities, he said.

Coller Capital’s summer 2021 Global Private Equity Barometer found that around a quarter of respondents said LPs were changing their policies around co-investing to allow for more allocation to co-investments.

“Most LPs participating in co-investments in a strategic way are looking to be more than just providers of capital. They would like to be a value-added partner,” Nelson said, perhaps contributing expertise through their own networks.

RedBird’s Carpenter said the process of growing into co-investing, for both LPs and GPs, can take time to refine. RedBird’s first co-investment was challenging, he said, but it was also a learning experience.

“Over time, with some of our larger co-investment partners, we’ve really figured out the right cadence,” Carpenter said.