"That's a big chunk of private investment activity," said Andrea Auerbach, a managing director and global head of private investments at Cambridge Associates LLC in Menlo Park, Calif. "Co-investments have become very mainstream."
What's more, increasing investor demand for co-investments is creating competition among limited partners. The competition is leading to "an enormous supply-demand imbalance," said Bryce Klempner, Boston-based partner at McKinsey & Co.
And investors are well aware of the increased competition. The $223.8 billion West Sacramento-based CalSTRS expects to increase private equity co-investments as it implements its collaborative investment model. That model for alternative investments could include everything from direct investing and joint ventures to syndicates of institutional investors joining together on a direct investment.
"LPs are having the same idea at the same time," said Margot Wirth, CalSTRS' director of private equity, at the pension fund's Jan. 30 investment committee meeting.
Some 10% of CalSTRS' private equity commitments have been to co-investments, Ms. Wirth noted during a discussion of the new collaborative model. Over the past four years, CalSTRS has committed $1.1 billion to 22 private equity co-investment transactions. "In two to five years we would like to at least double it," she said.
CalSTRS' co-investment returns have been mixed, topping its private equity portfolio for all periods except the 10 years ended March 31, when co-investments earned a 6.6% internal rate of return vs. 8.1% for its fund investments.
"Staff believes that increasing the private equity's co-investing activities presents the greatest opportunity for improving performance" and reducing total fees and incentives paid to outside parties," a January report to the investment committee on the private equity collaborative model stated.
But CalSTRS is not interested in only the potential for higher returns. Plan officials think the experience gained could serve as a bridge to direct investing, including leading or co-leading deals in the future, the report noted.
"Others (asset owners) are more advanced," Cambridge's Ms. Auerbach said, referring to Canadian, Asian and Middle Eastern pension and sovereign wealth funds.
"We do more co-investing and we'll do more of what we are already doing, but we are also doing more advanced co-investing," Ms. Wirth said.
The $354.7 billion Sacramento-based CalPERS also is looking at co-investments, restarting a program that has been dormant for the past few years. While CalPERS officials have been stingy with details regarding its new private equity model, CIO Yu Ben Meng in February highlighted its plan to expand its co-investment capabilities.
Some 9% of CalPERS' $27.8 billion private equity portfolio was in co-investments and direct investments as of Dec. 31, according to its latest private equity report. Cal- PERS' $2.3 billion co-investment and direct investment portfolio earned a 3.4% IRR for the one year, 9.3% for the five years and 15.3% for the 10 years ended Dec. 31. By comparison, returns for CalPERS' entire private equity portfolio, including co-investments and direct investments, were 12.5% IRR for the one year, 11.3% for the five years and 11.4% for the 10 years ended Dec. 31.