When it comes to private equity investments, there’s a business case for multi-manager co-investment funds versus single-manager primary funds, according to research by Capital Dynamics.

The global asset management firm published a research paper using Preqin data to compare how actual co-investment funds compare to single sponsor private equity funds of the same vintage.

It found the majority of co-investment funds outperformed primary private equity funds on both a median net internal rate of return and total value to paid-in basis for 1998 to 2016 vintage years. During this time period, the median net IRR for co-investment funds was 15.8 per cent, compared to 13.5 per cent for primary private equity funds.

Looking at 2009 to 2016 vintage years, the difference was even greater, with four out of five co-investment funds outperforming primary private equity funds on a net IRR basis. In these years, the median net IRR for co-investment funds was 18.9 per cent, compared to 14.6 for primary funds.

“Average outperformance is attributable to the lower overall costs of a co-investment fund for an investor compared to those of a conventional private equity fund,” the paper said. “Co-investment funds typically charge a one per cent annual management fee on committed capital and take 10 per cent of net gains in the portfolio as a performance fee. This is approximately half of what a typical buyout sponsor charges, and therefore has a significant impact on the gross to-net yield erosion, particularly on higher performing funds.”

As well, private equity fees and carried interest can lower gross returns by more than seven per cent and the multiple on invested capital by almost 0.6 times for a high performing fund, the paper noted, highlighting that co-investments can typically reduce these costs by half.

“However, outperformance is likely to be a combinational of the favourable fee structure and the co-investment manager’s selection skills and ability to construct a high-quality and appropriately-diversified portfolio,” it said.

Co-investments also include two levels of due diligence on the fund and have a shorter and shallower J-curve, the paper added. As well, certain primary private equity funds may be focused on a country or sector, while co-investment funds can choose deals from a more diverse range of sectors and geographies.

In addition to outperforming primary private equity funds, co-investments also have more favourable risk-adjusted return profile, said the paper. “While co-investment funds may be less likely to achieve internal rates of return in excess of 25 per cent, they are much more likely to deliver strong returns between 10 per cent and 25 per cent and far less likely to return zero or lost money.”