Institutional investors are increasingly bypassing traditional private equity funds by making direct investments alongside private equity firms, a trend that has accelerated amid persistent challenges in generating returns from conventional fund portfolios. These so-called co-investments, which offer lower fees and greater flexibility, saw their value more than double year on year, reaching a record $198 billion in the first half of 2023, according to S&P Global Market Intelligence.

Overall private equity fundraising reached $312 billion during the same period, a 5 percent increase compared to the previous year but still below the peak levels experienced in 2021. Industry participants suggest that co-investments are becoming an established strategy within institutional investing. Roger Vincent, founder of Summation Capital, a New York-based private equity fund, described co-investment as "increasingly a part of the institutional playbook."

Among public pension systems, North Carolina’s Investment Authority has been particularly active, committing $200 million alongside Baillie Gifford earlier this year to Anthropic, an artificial intelligence startup. If Anthropic goes public at a $21 trillion valuation, the deal could yield a fivefold return. Additionally, the authority has twice co-invested in continuation vehicles related to Ascent Resources, a U.S. natural gas producer, with the latest investment marked up approximately 20 percent within six months. Brad Briner, North Carolina state treasurer and chair of the authority, noted that roughly half of the state’s planned private equity allocation will be directed toward co-investments going forward.

The appeal of co-investments lies partly in their fee structure. Traditional private equity funds generally charge a 2 percent management fee and 20 percent performance carry, whereas co-investments often entail little or no fees, potentially boosting net returns. The Pennsylvania Public School Employees’ Retirement System (PSERS), which oversees an $86 billion portfolio, reported that its co-investments have outperformed its broader private equity holdings by about five to six percentage points, largely due to reduced fees. Benjamin Cotton, PSERS’ chief investment officer, emphasized that these savings "go right to the bottom line."

Co-investments also enable investors to exercise greater discretion over timing and sector allocation. The Alaska Permanent Fund Corporation, with $89 billion in assets, deploys up to a third of its private equity capital through co-investments, using them strategically to increase exposure in sectors like energy and financial services or to target specific geographies, according to Deputy Chief Investment Officer Allen Waldrop. The flexibility to invest opportunistically is seen as a key benefit given the sometimes slower pace of traditional fund commitments.

Despite these advantages, co-investments present challenges. Some experts caution that funds may reserve lower-quality deals for co-investors or that public pension plans may lack the expertise required to assess complex transactions quickly. Anton Orlich, deputy chief investment officer at the California Public Employees’ Retirement System, noted that co-investments had generally underperformed broader private equity portfolios over the past three decades until a recent reversal. Concerns over adverse selection and the speed of decision-making remain prominent. Nat Fraser, partner at Cerity Partners, warned of the risk inherent in co-investments, questioning why investors are granted access to certain deals. Monte Tarbox, chief investment officer at the New York City Retirement System, echoed this view, highlighting that deal terms are often "already baked" by the time co-investment opportunities are presented.

While the surge in interest suggests room for growth, capacity constraints limit how large the co-investment market can become. Industry professionals expect private equity managers to maintain a central role in deal sourcing and portfolio management, with co-investors augmenting but not replacing traditional fund investments. Fraser predicted that private equity fundraising and co-investment activity will eventually find a balance, determining the sustainable scale of each approach in the evolving market.