LPs warn of co-investment risks - AVCJ Forum

“In the past, when we have worked with a GP as a large investor, they have not distributed co-investment fairly. You have to be aggressive and tell them you are interested,” said James Kim, head of private equity at Korea Investment Corporation (KIC). “Even when we are big, their fund sizes are bigger. They look at their investor base and give opportunities to CPPIB [Canada Pension Plan Investment Board], which makes the largest [fund] commitments.”

KIC had $131.6 billion in assets as of year-end 2018. Of this, $21.6 billion – or 16.4% – was in alternatives, including $7.6 billion in private equity. The alternatives division was established in 2009 and initially focused on fund investments. KIC made its first direct private equity investment in 2010 and started co-investing alongside portfolio GPs in 2011.

Even though KIC is ranked by the Sovereign Wealth Fund Institute as the 14th largest sovereign wealth fund globally, its assets are less than half those of CPPIB. The Canadian pension plan had C$392 billion ($298 billion) as of March, of which C$93.1 billion – or 23.7% – was in private equity. Alternatives account for more than half of the portfolio.

CPPIB is an active co-investor in Asia; C$5 billion out of the C$13.6 billion of private equity capital it has put to work in the region is in direct deals. Jung Yup Lee, a senior principal in the Asia PE team, stressed the importance of strong underwriting. “You need an internal team,” he said. “We bring in a lot of people from GPs.”

Having people with skills and experience in direct investment is crucial at a time when demand for co-investment is arguably giving GPs more firepower than they can handle. If a co-investment opportunity is too large or complex when considered in the context of the resources of the manager offering it, an LP that underwrites properly would know to stay away.

Kim of KIC warned that, for all the attractions of co-investment in the form of reduced net fee exposure, it can result in sub-optimal outcomes. “We are wary that there is so much liquidity in the market and a lot of people are using [co-investment] as a marketing device,” he said.

Investors are also mindful of what might happen when the era of cheap debt and ever-increasing valuations comes to an end. KIC looks to protect its downside by insisting on covenant light loans when participating in co-investments. As for the funds side of its business, there is increasing interest in private debt, which currently accounts for just 10% of the PE portfolio.

Private debt is also a priority for the Public Officials Benefit Association (POBA). The Korean pension fund has more than half of its KRW13.3 trillion in assets in alternatives. Credit strategies have always been appealing, given the need to realize an absolute return every year, but the allocation is rising in response to the uncertain macroeconomic environment.

“We are reducing the public equities share of our portfolio and focusing more on private debt,” said Dong Hun Jang, CIO of POBA. Real estate and infrastructure form a large part of the alternatives allocation and the pension fund is looking more closely at debt strategies in these areas. This includes committing $200 million to a real estate loans joint venture with a US peer.

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• Topics
• North Asia
• LPs
• GPs
• South Korea
• Asia
• Co-investment
• Canada Pension Plan Investment Board (CPPIB)
• KIC
• Public Officials Benefit Association (POBA)