Co-investment vehicles (CIVs), a means for hedge-fund managers and their clients to invest alongside each other in one or more assets, are growing in popularity. The development reflects the overall drive by hedge funds to highlight how managers’ interests are aligned with those of investors – not just in fee structures, but in products and philosophies as well. The aim is to retain existing clients and win new ones.
Why hedge funds are making increasing use of co-investment vehicles
Drive to align interests spurring CIV launches
CIVs are well established in private equity, but hedge funds have begun to use them more often. That, according to a recent report by the Alternative Investment Management Association (AIMA) and the audit and tax consulting firm RSM, reflects their ability to align interests.1 The reports adds, ‘When you strip away the lively discourse around the outsized returns that some alternative investment fund managers can generate, the proactive efforts to align their interests with their investors are arguably the most attractive aspect of their offering.’
Alignment via CIVs is achieved in two main ways. First, by investing personal capital alongside that of the investor, the manager has ‘skin in the game’. Second, there is the concept of ‘sweat equity’: fees can be structured to ensure the manager is only compensated if the investment achieves the investor’s objectives.
Some managers, according to AIMA and RSM, are using the prospect of co-investment opportunities to attract institutional investors that don’t invest in their main offerings. They do this by ‘offering tiered fees that heavily favour those also invested in the flagship fund’.
Currently, just 23% of the 138 alternative investment fund managers surveyed as part of the report’s research use CIVs. However, that figure could grow considerably, given that the report adds that these structures may provide ‘the ideal vehicle for aligning interests’.
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Generating economies of scale
CIVs allow investment managers to exploit investment opportunities that don’t fit within the strategy or model of their flagship fund and that might otherwise go to waste. The international law firm Walkers adds that CIVs also appeal to activist investment managers, who can use CIVs as a channel ‘to increase influence by amassing sufficiently large positions to effect corporate change through board representation over time’.
Meanwhile, CIVs provide investors with a means of reducing the average fees paid to managers across the funds they invest in. (CIVs are typically offered on advantageous terms, according to Walkers.) Moreover, working more closely with a manager provides greater opportunities for knowledge sharing, allowing both parties to better understand the other’s philosophies, values and ambitions.
Walkers confirms the growing interest seen in CIVs, and it believes the trend will continue, driven by investor demand. ‘The largest and most active investors’, it says, ‘are seeking to allocate large sums to concentrated positions, and they see CIVs as a way to take advantage of an investment manager’s ”best ideas”.’2
In conclusion, the appetite for CIVs seems set to grow. Indeed, traditional launches of funds are increasingly enhanced by pre-determined allocations to CIVs for first-close or early investors.
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