2014 is set to witness an increase in co-investment activity, with 52% of LPs and 31% of GPs intending to ramp up their operations in this sector, according to a recent Preqin study.

However, the study cautions the high expense of co-investments and competition in the landscape could act as deterrents to those who express an initial interest.

Gaining prominence

The Preqin’s report highlights co-investments are passive, non-controlling investments, a provision of separate equity that is often not subject to fees. Despite carrying a greater level of risk and complexity, co-investments bring a myriad of benefits to both the investor and fund manager. Some of the benefits include better returns, diversification of portfolio, and better alignment of interests between partners and increased efficiency.

Based on a study conducted in February 2014 among 140 private equity LPs spread across the globe, the Preqin report reveals that over 73% of investors surveyed have co-invested alongside a GP in a deal in the past. The following graph highlights the breakdown of the LPs’ current plans for co-investments, with 40% actively seeking co-investment opportunities at present while 37% doing so on an opportunistic basis.

LP's current level of co-investment activity

Rationale for offering co-investment rights

Preqin also surveyed 80 fund managers spread across the world to understand their reasons for offering co-investment rights. The most promising reason why GPs offer co-investment rights is to build stronger relationships with LPs, with over 76% of respondents citing this as reason. Moreover, 51% of GPs view co-investments as a valuable method for gaining access to additional capital for deals.

The following graph highlights the benefits of offering co-investments as perceived by GPs:

GP's views on offering co-investment rights to LPs

The Preqin’s report also points out that the use of co-investor capital in deals alongside their funds would facilitate investment into larger transactions, which GPs may not be able to access with fund capital alone.

The Preqin’s report highlights the LPs and GPs plans for co-investment activity in the year ahead. As can be deduced from the following graph, 2014 is set to witness an increase in co-investment activity, with 52% of LPs intending to ramp up their operations in this sector.

LP's future plans for co-investment

The following graph highlights that 31% of GPs planning to offer more co-investment opportunities than they did in the previous year.

GP's future plans for co-investment

The report concludes that with the private equity industry maturing and the development of a more sophisticated investor community progressing, 2014 could witness an increase in co-investment activity, with benefits accruing to both fund managers and limited partners.