Private Equity Co-Investors Are Big Winners in Post-Crisis Times
The performance of co-investments, when non-private equity groups invest alongside funds in a company, has been higher after times of crisis than buyouts, according to a study by asset management firm Capital. Dynamics.
After the global financial crisis, for example, co-investment operations generated an average gross internal rate of return of 24.2%, compared to 18.4% for buyback operations.
Following the bursting of the Internet bubble, the performance gap is even more marked, with co-investments yielding 14.1% against 9.5% for LBOs.
For transactions in the top quartile after the Internet bubble, co-investments returned 72.8% against 43.8%; and after GFC co-investments, 46.3% against 40.3% for buybacks.
Several factors explain this outperformance, according to David Smith, senior managing director of Capital Dynamics. One of them is that there are greater opportunities for investors who remain in the market after a crisis when there is increased demand for capital.
“In each case, there was excess liquidity in one part of the market. What you see after the crisis is a collapse in liquidity and this, in turn, leads to a collapse in entry prices, ”Smith said. Citywire.
“There is a concept of pro-cyclicality in co-investment. Passing investors are there when the markets are good and they are absent when prices are falling. If you are an organization like ours that has committed capital for co-investment, rain or shine, you can pace your investment through the different vintages.
“One of the reasons for outperformance is a function of transient players leaving the market, so there is less supply of capital just when the demand for that capital increases after a crisis.”
Normally, Smith said there would be six or seven people in the room looking at a co-investment opportunity, but now most of the high net worth investors or banks have stopped.
Co-investments have become a popular way for limited partners – investors in private equity funds – to deploy their capital in recent years. It allows limited partners direct access to the returns of portfolio companies and their fee terms are generally better than when investing in a fund.
Presented at this year’s SuperInvestor conference in London, Capital Dynamics research analyzed 477 co-investment deals with 52% of deals completed by groups based in Europe, 46% by US-based companies and there remains in Asia.
The data covered transactions between 1988 and 2019, with a quarter of transactions concluded after the global financial crisis. In addition to IRRs, the research also looked at multiples of invested capital and found that, on average, post-GFC co-investment agreements had a return of 2.86 times, compared to 2.17 times between 2005 and 2008. .
In addition to being able to invest at lower multiples – currently around 6x to 8x the profits for co-investments – after crises, investors can also negotiate better terms, Smith said. Co-investors can invest in preferred stocks and stock warrants rather than common stocks of a company where investors would be most exposed to the volatility and risk of a company.
Meanwhile, the flow of transactions is increasing, Smith said. This is also the case now, where the number of transactions recorded by Capital Dynamics has increased significantly since the start of the pandemic compared to the number before.
He added: “It means you can be really selective. One of the most important things is smart portfolio construction. We diversify our portfolios by manager, year, industry and country. large, then you can be very selective about how you build your portfolio so as to meet those portfolio construction parameters. ‘
But he stressed that the pandemic is different from previous crises. In the past, there have been liquidity crises, but this time, according to him, it is a consumer crisis.
Therefore, the key has been to identify the sectors that have been affected by the pandemic, as well as those that would benefit from immunization programs.
While Capital Dynamics stopped investing for most of the year when Covid-19 hit, it relaunched its program after extensive research, with a focus on technology, healthcare, goods consumption and services.