Private equity investors speaking on panel last week challenged studies that suggest PE co-investments underperform fund investments and discussed the implications of a trend towards more direct deals.

At the AVCJ Private Equity & Venture Forum in Hong Kong, Marcus Simpson, head of global private equity at Queensland Investment Corporation (QIC), took issue in particular with a Harvard Business School/Insead study released in 2013. 

The research found that deals available for co-investment were higher risk and often underperformed fund investments. It was based on 392 investments undertaken by seven large limited partners between 1991-2011.

But Simpson said the study was dominated by one investor and involved a fair amount of venture capital and pre-2008 crisis deals, and he suggested that studies undertaken today might well yield different results.

QIC recorded an average 30% rate of return across 25 co-investment transactions – both realised and unrealised – since it started to make co-investments in 2007. That is more than double the return realised from the fund portfolio, which he said had been “running in the low to mid-teens” since it was set up in 2005.

Simpson, who set up QIC’s PE programme in 2005 and oversees $5 billion, noted that when it came to direct deals – as opposed to co-investment – it was probably too early to compare performance against funds.

QIC has been undertaking direct investments for seven years and there have not been any “blow-ups”, he added, but “as the tide goes out, some will get caught”. Indeed, as LPs shift from co-investments to doing more direct deals, Simpson predicted that there would be “much greater dispersion of returns between investors, as some get it wrong and some get it right”.

The shift to direct investments has resulted in QIC getting more involved with operational aspects of agribusiness in Australia, doing longer-duration direct deals and trying to leverage relationships alongside trade agreements.

Co-investments have significantly outperformed fund investments, agreed Su Weichou, Beijing-based partner at $12 billion private equity manager StepStone, speaking on the same limited partner (LP) panel – for his firm at least. He cited fund investment returns for StepStone of 15% compared to co-investment returns of 30%. 

However, Su said Stepstone had also looked at more than 1,000 co-investment transactions across 130 GPs and concluded that half of deals outperform and half underperform the fund they were investing alongside, resulting in an average that is in line with fund performance.

Another panelist, Michael Taylor, Tokyo-based managing director at HarbourVest Partners, a Boston-based $37 billion PE fund of funds, said his firm’s success with co-investments had been mixed.

He cautioned that investors should adapt their approach as market conditions change. There may be a lot of interest in co-investment today, said Taylor, but that will change in a few years.

By way of example, he said: “In the early days [20 years or more back] when we were doing co-investments, it was very venture- and growth-oriented because venture and growth funds were small – they needed follow-on capital.”

When the VC market took off in the late 1990s, there was less need for that co-investment capital, noted Taylor. “If you hung around too long, your performance was hurt by that – you should have been adapting more to co-investing in the buyout managers who at that point hadn’t ramped up their fund sizes.

“You can’t market-time,” he added, “but you have to pay attention to what’s happening to industry dynamics.”

Also speaking on the panel was Ralph Keitel, International Finance Corporation’s regional leader for PE fund activities, but he did not comment on co-investments.