LP Direct Investment: Disintermediating Private Equity Markets?


September 19, 2013

Last week we highlighted FT’s article about Canada’s Pension funds increasing their direct investment activities. The article references a paper by an INSEAD and Harvard research team that evaluated the performance of such investments over time.


This week we took a look at what is being said by Bain, for example, about the paper and an executive summary published in Working Knowledge . The researchers used proprietary data covering 392 deals by a set of institutions, both co-investments and direct investments, between 1991 and 2011.


It is the first study based on a large sample of the relative performance of direct investments by large institutional investors.  The authors of the study found a sharp contrast between the performance of “solo” deals compared to co-investment deals  (deals initiated and negotiated by buyout fund managers, giving their clients an opportunity to invest alongside them).


Solo deals outperformed. The underperformance of co-investments appears to be associated with the higher risk of deals available for co-investments. The outperformance of independent direct investments is due in part to their ability to exploit information advantages by investing locally and in settings where information problems are not too great, say the authors, as well as to their relative outperformance during market peaks.


Despite the quality of the data used, the authors said that data must be interpreted “cautiously”. The internal rate of return for seven direct programs were examined, points out Bain and Co, adding that the direct programs in the study were large, experienced PE investors that had strong local connections for industry intelligence and deal sourcing.


The authors of the study caution that small investors replicating a direct investment strategy “may have different experiences”. Some direct deals that are less than stellar include Dubai’s sovereign wealth fund struggle with some direct investments in Europe.


And Omers’ co-investment in Cengage, the US college alongside Apax Partners for USD 7.75 bn at the peak of the buyout market in 2007 resulted in a bankruptcy protection filing in July, according to the FT.


Bain concluded in its commentary on the study that even for large LPs, direct investing is “a big leap from conventional fund investing or active co-investing. To build a credible program requires end-to-end investment capabilities that take a lot of time and money to build.”

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