Is co-investment Pacific’s answer to large project funding requirements?

Introduction

The Pacific region offers compelling opportunities for investment, whether it be the privatisation of a national bank, or the creation of a large resort or an integrated property development. For single investors, however, such large-scale investments may result in liquidity or diversification exposure, which may make a single investor unwilling or unable to take up the investment.

Co-investment may be an effective way to take advantage of such opportunities whilst also addressing the issues of scale in the Pacific. As a result, co-investment is fast becoming a buzzword especially in the Pacific where the sheer size and exposure to large assets have commonly held back investments made by institutions and funds. However, making use of a co-investment model requires thoughtful planning.

Before we delve further into co-investment, it is important to define it. Co-investment is ordinarily broadly defined as any form of joint venture or pooling of capital between two or more parties or groups to participate in an investment. However, in a finance context, co-investment carries a more technical definition, being the complementary investment made by an investor directly into a business through a private equity fund or a special purpose vehicle that acquires the majority stake in that business. Through this process, co-investments provide exposure to larger high-yielding assets without channelling funds into a single transaction, while also reducing management fees by investing directly into the business.

For the purposes of this article, we use the more broadly defined term involving any form of joint venture between funds and institutions. More specifically, we will look at whether co-investment can be an effective means for larger investment projects to facilitate greater investment, growth and a regional flow of funds in the Pacific.

When is co-investment the answer?

In the Pacific region, when governments have sought to privatise a national bank, utility company or when a large scale resort or property development has required capital, there is the practical hurdle of a relatively small number of domestic investors or funding options. Along with the financial institutions and regional development banks, superannuation funds make up for the bulk of the locally-sourced capital in domestic markets in the South Pacific. Simply put, whether it’s a major recapitalisation of a private sector development or a divestment of a national interest by the governments, these superannuation funds generally become the top contenders as sources of domestic capital.

However, as attractive as some of these investment opportunities are, the exposure on any individual portfolio could be higher than what investment policies allow; for example, it may be outside a fund’s investment guidelines to invest as a majority shareholder. Superannuation funds in the Pacific already have fairly large and often dominant domestic exposures (and often concentrated in one or two industries, especially tourism). Also, being a large single player, often these funds are faced with liquidity issues, should they ever wish to exit.

This is where working together with other funds outside the domestic market to co-invest in bigger projects can mobilise a regional flow of funds. As intra-Pacific trade grows, giving rise to more regional investment opportunities, co-investment by financial institutions across the region will both enable diversification through regional exposure and manage liquidity risk. These initial forays into co-investing could also provide a means to attract capital from outside the region.

At the recent Pacific Islands Investment Forum (Forum) held in Cook Islands, co-investment was recognised as one of the essential moves that regional funds need to consider. The Forum was attended by funds from the across the region, with a net worth totalling $70 billion, which further serves to highlight the fact that these funds are one of the major mobilisers of savings in the Pacific.[1]

What to be mindful of?

While pooling funds and co-investing can reduce risk and bring together friendly parties and access to capital, like any other relationship, it may seem simple at the surface but much more “complicated” in reality. Depending on the structure adopted, co-investment can come with its fair share of complications. So complicated, in fact, that often such joint ventures are compared to marriages!

In order for any co-investment to work successfully, it is very important to ensure that the investment objectives of all parties involved are aligned. Apart from focussing on required returns, risk appetite and investment periods, funds should also be mindful of the different cultural backgrounds, values and expertise that get pooled together for such co-investments. The success of such co-investments hinge on a number of factors such as developing a co-investment partnership, appraising the regulatory environment for such investment and managing the partnership going forward.

Like personal relationships, making sure partners are compatible in terms of financial objectives such as returns expectations and investment time horizons is essential. Some funds may not be used to being passive or minority investors. Having in place shareholder or co-invest agreements which lay out the rights, roles, responsibilities of each investor as well as dispute resolution mechanisms and exit strategies can be a mammoth task when trying to satisfy a number of different players.

Once projects and partners have been identified and matched, there are various other issues to be considered. While investing beyond the domestic market brings diversification, it also brings along a geographical distance which may affect the flow of information. International investments create additional exposures due to the different legal and administrative requirements in various jurisdictions within the Pacific.

It is also worth noting that investment policies of various funds may sometimes restrict offshore investments, and may require an additional layer of approval processes. This can often result in a drawn-out process where opportunities can be missed. Moreover, the country in which the investment opportunity exists may have rules against offshore funds investing in certain activities, particularly where assets are of national interest. This can be tricky when privatising national assets.

Conversely, the congregating of similar minded and structured investors (such as a group of regional superannuation funds) provides exit opportunities in itself to any one such fund which, for some reason, needs to leave ‘the pool’. That is, a fellow fund investor may be able to simply pick up the exiting fund’s interests under the co-invest arrangements. In that way the project itself can provide sufficient liquidity to give comfort to the investment committees of the funds.

Sharing the risk?

As trade between Pacific island economies grow, there is no doubt that more funds and financial institutions will venture out and capitalise on the large co-investment opportunities presented on a regional platform as they look to diversify and better manage their liquidity risks.

While co-investment may be the answer to tackling large investment opportunities, be it a private sector development or a public infrastructure project in the Pacific, this collaboration does require careful consideration, including alignment of interests and compatibility of investment partners.

The Pacific Legal Network has extensive experience across the Pacific with regards to multi-jurisdictional investments and joint ventures, and is leading the way in introducing co-invest opportunities to its clients and contacts. If you are considering similar ventures, please get in touch.

[1] http://www.cookislandsnews.com/item/69500-forum-helpful-for-super-fund/69500-forum-helpful-for-super-fund