The power of co-investments in secondaries

Co-investments can help a secondaries buyer bridge any financing gaps to purchase a large portfolio.

Co-investments can help secondaries buyers bridge any financing gaps and enable them to buy a large portfolio.

Blackstone’s Strategic Partners recently raised eyebrows when it emerged as the buyer of the California Public Employees’ Retirement System’s $3 billion portfolio of legacy real estate fund interests.

At first, a number of industry participants I spoke to were surprised, saying that Strategic Partners may not have enough dry powder on its own to close the deal (its most recent fund closed on $4.4 billion in October 2014 and is thought to be quite significantly deployed). But it soon became clear that Strategic Partners had brought in more than 10 co-investors to close the deal – and swiftly.

“They are sophisticated investors that can move quickly,” said a source familiar with the transaction, noting that co-investments added to the transaction’s complexity. Not only did Strategic Partners have to underwrite more than 43 fund stakes with 350-plus underlying investments, but it also had to raise an undisclosed sum from LPs, which included public pension plans and sovereign pension funds, all wanting to co-invest. All rather impressively done in a matter of months.

Co-investments have been steadily gaining ground across alternative asset classes – witness Ardian closing on €1.1bn this week for its fourth co-investment fund – so it’s natural they have become a growing part of the secondaries universe, too. That’s particularly the case for private equity real estate secondaries, an area with increasing supply that seems to exceed current levels of dedicated dry power.

“Although there’s a finite amount of capital, there’s often the ability to punch well above your weight class by bringing in a couple of these folks,” said one fund of funds manager focused on the real estate secondaries market. “There’s a pretty big bench of LPs out there that if there’s an attractive deal … will ride your coat-tails of underwriting. And they’re willing to do that in a pretty quick manner.”

For LPs lacking the in-house expertise and ability to buy directly in the secondaries market, co-investments can be the next best thing.

That said, not all investors will automatically be given such opportunities; most of the largest secondaries players have co-investment arrangements with their existing LPs but these take different forms. Some large buyers raise separate co-investment funds while fundraising for their main vehicles. In other cases, existing investors that have flagged a desire to co-invest might be shown opportunities on a deal-by-deal basis.

“Ninety percent of the time, if you want access to co-investments, you need to be an investor in the fund,” said a London-based advisor. “Sometimes, you even need a minimum commitment size to the main fund to be able to do co-investments.”

In the case of funds of funds, sometimes they will make secondaries co-investments available to LPs in their primary funds, too.

Often, the secondaries buyer acts as the lead and brings co-investors in. Other times, it’s the advisor who’s tasked with lining up co-investors. The secondaries firm typically secures the terms of the transaction, while the co-investors, more passive, simply adopt them.

“It’s quite diversified and every deal is a bit different,” the advisor said.

For now, co-investment appetite in the secondaries market is big, both in private equity and in real estate, but it’s not clear whether that’s a cyclical trend, with pension plans and sovereign wealth funds potentially retrenching for when the economy turns and distributions slow, or if it is here to stay.

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