Private equity giant Hamilton Lane says the growing popularity of PE co-investment in Asia – coupled with a lack of regional investor experience in this area – could lead to withdrawals from the asset class if deals were to blow up.

Limited partners participating in such deals in the region often lack professional investors’ skills and knowledge, according to chief executive Mario Giannini and chief investment officer Erik Hirsch.

Sources say family offices in Asia often lack the right approach and expertise for the asset class.

Co-investments involve limited partners (LPs) in a PE fund putting additional money directly into other deals alongside the general partner of said fund.

“One of the things that worries us on the co-investment side is that, if those deals go bad, they go bad in a big way,” said Giannini, whose firm has $220 billion under supervision, including co-investments.

Such an outcome could lead to some LPs exiting PE as an asset class, he noted, although much depends on the prevailing market environment.

Data provider Preqin’s initial estimate is that global PE fundraising amounted to $486 billion in 2014, but it expects that figure to rise by 10-20% as more information becomes available. Hamilton Lane estimates that co-investment added 33% to US PE fundraising in 2012 and 2013, up from an average of 25% since 2007 – and says that proportion has also risen in Asia.

Hirsch said the desire to co-invest has risen significantly in recent years but many LPs have yet to acquire the skills necessary to undertake this kind of investment.

Furthermore, academic research points to the underperformance of co-investments, with returns of around half the overall average. Either LPs adversely select investments or general partners adversely select investments they show to LPs, said Hirsch.

Giannini warned that the volatility and fickle nature of the PE market meant it was particularly at risk when investments failed. Canadian LPs, for instance, were big co-investors in the 1980s, he said, but washed their hands of such deals after one big deal – Rogers Cablevision – blew up.

Similarly, Japan’s PE market blows hot and cold. “Some years it’s really good, then activity just goes to zero,” said Giannini. “That may change if GPIF [Japan’s $1.2 trillion Government Pension Investment Fund] really invests in PE. That will send an enormous signal to the market.”

Another issue is that LPs are less prepared for the volatility that co-investing might bring, he said. “It’s not like a partnership where you’ve got 15 deals. If one goes bad, it’s not a big deal because the other 14 are doing OK.

“If co-investments start going bad, a lot of investors will see real losses in their portfolios,” added Giannini. “They will see a line item that says ‘negative 80’ – I’m not sure that they’re all prepared for that kind of volatility in their portfolio.”

Rodney Muse, managing partner of Malaysia-based Navis Capital Partners, agrees that the desire to do co-investment deals had been rising but many potential investors lacked the skills to succeed.

“Some LPs really do understand what it means to co-invest,” said Muse. “That’s different from people who say, ‘if you have a co-invest let us know and we’ll try and see how it might fit into our unstructured thinking’. Those investors rarely make it to the closing table.”

Raju Ruparelia, senior principal at Ontario Teachers’ Pension Plan, a $118 billion LP that has long invested in PE, agreed that co-investments are becoming more of a viable option in Asia as more big deals become available.

But he stressed it is important for LPs to be clear about what they were trying to get out of their co-investment programme – whether lower fees or a desire to put more capital to work or develop an in-house team to make direct investments. Ruparelia was speaking at the Hong Kong Venture Capital and Private Equity Association’s Asia Private Equity Forum this week.