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The crowding-out effect

The rise of semi-liquid funds could crowd out large institutional co-investors.

The rising popularity of funds dedicated to high-net-worth individuals could crowd large institutional investors out of co-investment opportunities.

These semi-liquid vehicles—funds that offer perpetual entry and periodic redemption tailored to individual investors’ risk appetites—open up a novel and expansive pool of capital that enables GPs to finance deals directly.

With more capital to commit and returns to generate, the new swath of high-net-worth LPs will compel managers to increase their deal flow, said Stephen Brennan, head of private wealth solutions at Hamilton Lane.

If GPs are unable to deploy at a greater clip, co-investment opportunities will be the first deals to go.

Lacking a sufficient supply of suitable acquisition targets, asset managers will face fewer instances where they’ll need to call cash from outside investors to complete a transaction.

“These managers are going to need to increase their deal flow significantly in order to invest their semi-liquid or evergreen funds and provide co-investment deal flow to their large institutional investors,” Brennan said. If they can’t make this happen, it will be the “co-investment deal flow that will dry up first.”

Keeping the fee

Blackstone’s BXPE, its $1.3 billion fund for wealthy individuals, is one of few examples of a fund dedicated to exposing high-net-worth investors to PE. Brennan said that if other prominent asset managers build out large products dedicated to the space, there will be even less capital available for co-investment commitments.

“Today, if [a GP] has their buyout fund, their evergreen fund and a large deal, they’re going to start by allocating it to their buyout and evergreen funds,” he said. “Then, whatever’s leftover, they could syndicate out to co-investors.”

This is, in part, a product of the fee structure. The wealth channel-focused funds could signal an end to the fee concessions and favorable terms managers use to attract large LPs, said Kevin Gallagher, a principal at consulting firm Casey Quirk who advises investment managers on fund distribution, operating model design, and M&A strategy.

With capital coming in from semi-liquid funds that use a fee structure similar to that of mutual funds—in which LPs pay continuous, periodic fees—large GPs could have less incentive to ease terms for public pensions plans and sovereign wealth funds, he said.

In terms of fee negotiation and co-investment opportunities, “Evergreen funds and large institutional investors could become on par with each other,” Gallagher said.

Co-investments and evergreen funds

Asset managers often use equity co-investments to finance larger deals.

The co-investor—typically a public pension plan or sovereign wealth fund—makes a minority investment in a company alongside a PE fund in exchange for direct exposure with no management fees.

Co-investments have become an increasingly popular practice as asset managers expand their LP bases and increase their average deal sizes. Over the past decade, 30% of all global PE deals have included co-investors, according to PitchBook data.

Some of the largest deals announced over the past few years have involved co-investors. Early last year, tech-focused PE firm Silver Lake partnered with the Canada Pension Plan Investment Board to complete a $12.4 billion take-private of Qualtrics, a B2B SaaS company.

In 2021, Blackstone, The Carlyle Group and Hellman & Friedman bought medical supply company Medline Industries for over $30 billion. The deal included co-investments from the Abu Dhabi Investment Authority and GIC, Singapore’s sovereign wealth fund.

The rise of semi-liquid, evergreen funds dedicated to wealthy individuals could decrease the number of these kinds of deals.

Early days

Still, it’s too early to tell whether these products will in fact limit co-investments.

“For ultra-high-net-worth, it’s still early days,” said Gaurav Joshi, head of EY-Parthenon‘s US wealth and asset management strategy. “But I think the direction of travel is clearly from single-source co-invest opportunities to a portfolio approach.”

This means managers will pull capital from across their portfolios to get a deal done.

Gallagher agreed: “We’re certainly not at the stage where [institutional] investors have no opportunities, but it’s always a concern,” he said.

Individual investor-tailored products in other asset classes, like private credit and real estate, offer some early glimpses into the potential effects of the growth of these products.

Blackstone’s private credit vehicle has a demonstrated history of high yields and increased its monthly distributions in 2023.

On the other hand, Blackstone Real Estate Income Trust placed a limit on withdrawals after a spike in redemptions in 2022. Since then, BREIT has received a capital infusion of $500 million from the University of California and is reportedly seeing fewer outflows.

In November, Brookfield Oaktree Wealth Solutions launched its Brookfield Infrastructure Income Fund, a semi-liquid fund for individual investors.

Large managers weigh in

David Levi, head of Brookfield Oaktree, said while these products could limit co-investments at smaller managers, larger managers will be able to write even bigger checks armed with individual investor and co-investor capital.

“If you’re a smaller manager, it’s possible that co-investors get eaten up by the semi-liquid fund, or vice versa,” Levi said. “At Brookfield, we are running massive, massive checks. Our investment size is such that that’s not a concern for us.”

Still, Levi said the issue is a relevant point for the industry.

Blackstone holds a similar point of view, according to a person familiar with the firm. While the concern for co-investors is not misplaced, the influx of individual investor capital will allow the firm to complete larger deals without having to rely on third-party capital.

Featured image by Marco Bottigelli/Getty Images

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