As 2025 unfolds, a subtle but significant shift appears to be underway for pension funds in respect of their approach to private equity investments. Following an extended period of rising prices, as deal abundance and successful exits are coming to an end, market conditions are compelling pension funds to shift away from direct ownership and management of portfolio assets.
Instead of competing directly with buyout funds at the point of acquisition, it is becoming more common for pension funds to seek strategic partnerships with buyout managers and access to deals through co-investment opportunities with those managers. The direct investing model appears to be in retreat.
Changing markets have affected risk appetite
Historically, it has been commonplace for pension funds to compete directly with buyout managers for the keys to portfolio investments, seeking a direct ownership interest and engaging in active management of the underlying business. Pension funds have built sophisticated investment teams capable of executing the same transactions that buyout funds would compete for, while not incurring the external management fees and having direct control over whether, when and how to exit investments. This strategy has typically coexisted with parallel allocations to both regular buyout funds and co-investment opportunities alongside such funds, often offered by the same managers.
With the onset of deal scarcity, increased business risk, rising costs and exit challenges, direct ownership is falling out of favour with pension funds as investing in or with buyout funds increasingly becomes the preferred option in the market.
Pension funds managing portfolio investments have found themselves under the same pressures as other asset owners, faced with rising costs of capital, increased energy rates and supply-constrained markets in materials and labour. While each market is different, this set of circumstances has generally made direct investment in business assets a considerably riskier prospect than it has been in prior years, leading pension funds to ask whether it is a worthwhile allocation of capital.
In addition, subdued customer-facing markets demand more of portfolio assets and pension funds as direct owners may find themselves having to get more directly involved in management to meet these challenges, increasing their carrying costs. This, in turn, brings the cost of attracting and retaining talent to manage direct asset holdings, with hands-on management demanding bigger teams and greater organisational complexity. Ultimately, the pension fund must chase more and more value creation to try and secure an exit, just as those exits are increasing in difficulty.
Many industry participants will have experienced first-hand the restricted availability of exits in an environment of higher borrowing costs, finding asset prices on a plateau with a diminished pool of buyers in both public and private markets. While some pension funds will have been able to unlock liquidity through asset sales or otherwise, more than a few will have found the exits blocked at the desired price and will be in no rush to repeat the experience with new direct investments.
In the current economic and geopolitical environment, previously attractive investments come with an increased level of risk, while many high-quality assets remain off the market. The resulting lack of attractive investments available to buy at an acceptable level of risk has made direct investment unappealing for pension funds, where not so long ago it was readily embraced.
Navigating a new paradigm
With direct ownership and management of portfolio businesses becoming less attractive to pension funds, managers seeking exposure to private equity assets will now typically be either making direct capital commitments to buyout funds or seeking to participate in co-investment opportunities arranged by buyout fund managers to invest alongside their funds.
These options share some common attributes, allowing the pension fund to maintain an allocation to private equity without the additional business risk of direct ownership. The buyout fund manager performs the task of identifying attractive portfolio targets in a time when these deals are scarcer and require greater due diligence. Each retains a degree of exposure to the upside of any deal, as well as leaving open the possibility of accessing liquidity either on the secondary market or through a continuation fund, rather than having to sell the underlying asset.
From a commercial perspective, co-investment opportunities are usually characterised by preferential management fees (if any) and a more favourable performance allocation following an exit. The targeted nature of these structures also allows a pension fund to assess its participation in the underlying investment on a case-by-case basis, as opposed to being an investor in the main fund. Further, the restricted offering by invitation will often allow the investor more of a say in the structuring and management of the co-investment vehicle itself.
In an environment of constrained deal supply, the relative desirability of these opportunities drives a dynamic where access to co-investment deal flow becomes a key asset of any pension fund in the space.
To secure that access, a pension fund will depend on its relationship with the buyout fund manager. This explains the increasing prevalence of ‘strategic partnerships’ in the market, where a pension fund makes certain commitments to a buyout fund manager (such as investing in its flagship funds) in exchange for an invitation to participate in co-investments alongside those funds.
The benefits of this arrangement are evident in an uncertain market, giving the pension fund preferential access to a restricted pool of attractive opportunities and allowing the buyout fund to publicly welcome an institutional strategic investor as a vote of confidence in its management.
Co-investing through Cayman Islands vehicles
As with private funds more generally, the Cayman Islands is the leading offshore jurisdiction in which to structure co-investment vehicles. Pension funds and buyout fund managers alike will be familiar with its attractive offering of stable government, flexible legal structures, a world-class service sector, and a robust court system.
Co-investment vehicles with more than one investor will likely be required to register with CIMA under the Private Funds Act (as amended). Cayman Islands legal counsel can advise on this analysis and the registration process, as well as advise on the exempted limited partnership agreement for the co-investment vehicle and all other matters of Cayman Islands law.
Andrew Barker contributed to this article.
Daniel Walford is a senior counsel in the Global Investment Funds Group and is based in Walkers’ Cayman Islands office.
Christine Ballantyne-Drewe is a partner in Walkers Global Investment Funds Group
E christine.ballantyne-drewe@walkersglobal.com
C +1 345 526 4550
Andrew Barker is a partner at Walkers in the Cayman Islands.
