• Fund V deployed since 2020, targeting mid-market managers in EUR 200m-EUR 400m deals
• Strategy helps smaller LPs diversify, offering lower fee structure
• Fund VI was registered in April 2023

Switzerland-headquartered asset manager Capital Dynamics is nearing full deployment on the fifth iteration of its co-investment strategy as the sponsor sees a return of deal flow in Europe, Senior Managing Director Oliver Schumann told Mergermarket.

Capital Dynamics Mid-Market Direct V held a final close on USD 578m against its USD 500m target in May 2022, according to Mergermarket data. Schumann, who leads the strategy, added that Fund V started deploying in 2020 so has seen good vintage diversification, making around 10 deals from a 200-strong opportunity pipeline every year.

The sponsor refused to comment on future fundraising. However, Fund VI was registered in Luxembourg in April 2023, according to Mergermarket data.

The funds, typical of other co-investment strategies, have fees of 1% and 10% (referring to the management fee and performance fee) compared to 2% and 20% in a standard buyout fund so sees lower gross-to-net yield erosion, said Schumann. Co-investment strategies can also add to global diversification, particularly for smaller LPs like family offices.

Co-investment is just one of Capital Dynamics’ strategies, alongside fund-of-funds, secondaries and private credit.

Investments

Capital Dynamics positions its co-investment strategy in the mid-market, deploying sweet spot tickets of EUR 10m-EUR 30m in companies with an enterprise value of EUR 200m-EUR 400m to take 5%-30% equity positions. It typically invests in healthcare, industrials, business services, and the discretionary consumer sector.

“A lot of people are dropping out of the co-investment market, especially where we focus in the mid-market,” said Schumann. “Some LPs like pension funds have their own balance sheet and internal problems so this ensures strong deal flow for us.”

The mid-market is also seeing more deal flow, although Capital Dynamics remains very selective over which deals it takes on within its network of 300 GPs. The returns [for Capital Dynamics to consider investing] have to be at least 2x money and 20% net IRR,” he said, adding that in the wider sector, some buyout funds are seeing returns coming down to 15%.

It can come into the process pre-close or post-close, with the latest stage being when a deal is signed but the buyer wants to syndicate the equity, and its typical spot being when the bidder is in exclusivity.

The sponsor also has to have a high conviction about the manager, looking at the track record for its core deals, and how far it has deviated from its original strategy and original buyout thesis over the years.

It invests and exits on the same terms as the majority owner. “The biggest risk we end up with is where the majority owner is not as we expected,” said Schumann.

Around 40%-45% of the fund has been deployed in North America, 40%-45% in Europe, and the remainder in Asia. The past year has seen heavier deployment towards the US due to higher quality deal flow and better downside protections, he said.

However, the tide is now starting to shift back to Europe as it sees an increasing number of deals there. “The mid-market is being pressed from all angles: macro, interest rate, the consumer crisis, operation and supply chain issues, digitalisation and AI on the horizon,” he said, adding that this should create great opportunities for private equity funds.