Direct investing and fund investing serve distinct roles in institutional portfolios. Direct investing offers control, lower fees, and customized governance but demands operational capacity and capital scale. Fund investing provides diversification, professional management, and liquidity with lower minimum commitments. Most large asset owners deploy both strategies in complementary allocation structures.
Direct investing and fund investing serve distinct roles in institutional portfolios. Direct investing offers control, lower fees, and customized governance but demands operational capacity and capital scale. Fund investing provides diversification, professional management, and liquidity with lower minimum commitments. Most large asset owners deploy both strategies in complementary allocation structures.
Why Are Asset Owners Moving Toward Direct Investing?
The shift toward direct co-investments reflects both structural and financial pressure. Over the past decade, the median management fee charged by private equity funds has remained sticky between 1.5% and 2.0%, according to Preqin's 2024 Fee Survey. For a $100 billion institutional investor, this translates to $1.5–2 billion in annual management fees across private markets allocations—a figure that has prompted systematic fee negotiation and, increasingly, in-house direct investment programs.
The Canada Pension Plan Investment Board (AUM $623 billion) reported in its 2023 Annual Report that direct co-investments represented 34% of private equity holdings, generating a 1.0% fee drag versus 1.8% for comparable pooled funds over a five-year period. This gap compounds across decades and justifies the infrastructure investment required to operate a direct team.
Directional data from the Institutional Limited Partners Association's 2024 Member Survey indicated that 71% of respondents with over $10 billion in AUM had expanded direct investing allocations in the prior 24 months, driven primarily by fee pressure and governance demand—not necessarily superior returns.
How Does Operational Capacity Constrain Direct Investing Programs?
Direct investing requires dedicated deal sourcing, underwriting, diligence, and board-level governance. A functional direct program typically demands 15–35 investment professionals, depending on ticket size and sector focus. The Teacher Retirement System of Texas (AUM $195 billion) maintains a 40-person direct investing team responsible for approximately $45 billion in deployed capital, equating to roughly one professional per $1.1 billion in direct AUM.
This operational burden creates a threshold effect: asset owners below $5–10 billion in total AUM struggle to justify dedicated head count. Instead, these institutions access direct co-investment through secondary platforms (Lexington Partners, Partners Group) or through formal co-investment vehicles managed by fund sponsors. The Alaska Permanent Fund Corporation (AUM $84 billion) uses a hybrid model: fund allocations for core exposure, co-investment opportunities sourced through existing manager relationships, and limited secondary activity.
Board-level governance represents a less obvious constraint. Direct deals require investment committee review, often with due diligence presented to board audit or investment subcommittees. Funds delegate this governance to professional managers. According to the 2023 Global Pension Fund Survey by Towers Watson, 67% of respondents identified governance complexity as a material barrier to scaling direct investing.
What Are the True Cost Differences?
The cost advantage of direct investing is real but not uniform across all deal types and vintage years.
Traditional fund allocations carry two fee components: management fees (typically 1.0–2.5% of committed capital, declining as funds age) and carried interest (20% of profits, after preferred return thresholds). For a $100 million allocation to a 10-year private equity fund with a 2.0% management fee and standard carry, the total cost burden reaches approximately $2.5–3.5 million annually during the investment period, then declining as capital is returned.
Direct co-investments typically involve no or minimal management fees (sometimes 0–25 basis points for dedicated co-investment vehicles) but carry the same profit-sharing terms as fund sponsors: 10–20% carry, depending on deal structure and competitive positioning. CalPERS reported in its 2023 Private Markets Review that direct co-investment costs averaged 35 basis points in management fees plus 15% carry, against fund averages of 125 basis points in management fees plus 20% carry—a savings of roughly 90 basis points annually, compounding over holding periods.
Secondary market purchases (buying existing fund positions from other LPs) occupy a middle ground: management fees are lower (often 75–125 basis points) because the secondary fund manager is not executing new deals, but carry structures remain similar to primaries.
How Do Governance Structures Differ?
Fund investing places governance responsibility with the fund's general partner. Limited partners retain contractual governance through consent rights (for related-party transactions, key person clauses, removal provisions) and advisory board participation. This is a delegated model.
Direct investing requires a fully internalized governance model. The asset owner's investment committee must evaluate each opportunity, present findings to relevant subcommittees, and secure board-level approval before capital deployment. Documentation requirements are substantial: investment memos, diligence reports, valuation frameworks, and ongoing monitoring protocols.
What Is Fiduciary Duty for Asset Owners? provides a framework for understanding how governance standards apply equally to direct and fund decisions, but the operational intensity differs markedly. A pension fund investing via a fund manager relies on that manager's governance and compliance infrastructure. A pension fund making direct co-investments assumes full responsibility for governance, legal review, and regulatory compliance.
The Norwegian Government Pension Fund Global (AUM $1.3 trillion) operates a hybrid governance model: fund investments are managed through a separate fund investing arm with delegated authority, while direct holdings of strategic infrastructure assets (power grids, data centers) flow through full board-level approval processes aligned with its exclusion and engagement policy.
What Is the Performance Evidence?
Performance data comparing direct and fund allocations is inherently biased because direct investors are typically more selective and better capitalized. Nevertheless, publicly available benchmarking suggests modest direct outperformance in mature markets and vintage years.
Cambridge Associates' U.S. Private Equity Index for 2023 reported that co-investments (a proxy for direct) outperformed pooled private equity funds by 1.1% annually (net of fees) over the 10-year period ending December 2022. However, this figure likely reflects selection bias: larger, more sophisticated LPs access the best co-investment opportunities, while smaller investors receive secondary or lower-quality reservations.
Sector and vintage matter. Direct infrastructure investments (power, transportation, utilities) have historically underperformed direct private equity and venture capital, reflecting the lower risk and return profile of utility-scale assets. Power and Grid Investment for Asset Owners examines how institutional investors approach direct infrastructure allocation, where fund structures (closed-end core+ and open-end core infrastructure funds) often outperform direct ownership due to operational scale and manager expertise.
In venture capital, the picture inverts. Direct venture investments by leading institutional investors (Stanford Management, Yale Investments) often outperform top-quartile venture funds, reflecting founder relationships and hands-on operational involvement. Preqin's 2024 Venture Capital Benchmarks show direct venture allocations achieving a 28% IRR median (top quartile) versus 18% for pooled venture funds (top quartile) over the 10-year vintage 2013–2014 period.
The takeaway: direct investing does not guarantee outperformance, but it allows sophisticated investors to avoid the worst-performing funds and to access the highest-quality opportunities within sectors where manager quality is most dispersed.
How Should Asset Owners Structure a Blended Allocation?
Most large asset owners employ a three-pillar model:
Tier 1: Fund Allocations (60–75% of private markets capital). These are commitments to established fund managers in primary vehicles (buyout, venture, infrastructure, credit funds). Fund allocations provide diversification, professional management, and liquidity optionality through secondary sales. Asset owners prioritize managers with strong long-term track records, reasonable fee structures, and alignment mechanisms (co-investment alongside LPs, meaningful co-founder carry).
Tier 2: Co-Investment and Secondaries (20–35% of private markets capital). These are direct stakes in portfolio companies alongside fund sponsors or purchases of existing fund positions at discounts to NAV. Co-investments reduce fee drag on top performers and allow seat-on-the-board governance for strategic holdings. Secondaries provide entry points into mature, performing investments at lower valuation multiples.
Tier 3: Direct Continuation and Restructuring Vehicles (5–15% of private markets capital). These include bespoke structures for managing mature portfolio company exits, continuation funds (keeping a performer with reduced fees), and portfolio restructurings. These vehicles typically involve smaller deal teams and command lower management fees.
The Canada Pension Plan Investment Board allocates approximately 34% to co-investments, 55% to fund commitments, and 11% to secondary and structured vehicles, reflecting a mature, highly capitalized institution. The State Teachers Retirement System of Ohio (AUM $90 billion) reports a 70% fund / 30% direct split, reflecting its preference for operational efficiency and reliance on manager selection rather than in-house sourcing.
What Are the Emerging Trends in Direct Allocation?
Three trends are reshaping direct investing for large asset owners:
Continuation Vehicles and GP-Led Secondaries. Fund sponsors increasingly offer continuation funds that allow LPs to extend holding periods in performing companies while reducing management fees. This hybrid structure appeals to asset owners seeking direct-like economics without the full operational burden. Blackstone, KKR, and Carlyle have each raised $5–15 billion continuation vehicles in recent years.
Thematic Direct Programs. Rather than seeking broad co-investment exposure, leading institutions are building direct programs around defined themes: digital infrastructure, energy transition, and life sciences. Digitisation as an Investment Theme for Asset Owners and Data Center Power Demand and the Grid, for Asset Owners explore how direct investing in digital and power infrastructure allows asset owners to align capital deployment with long-term thematic conviction and governance mandates.
Semi-Liquid Direct Vehicles. Managers including Partners Group, Lexington Partners, and Intermediate Capital Group have launched semi-liquid direct funds with quarterly or semi-annual redemption windows, blurring the boundary between direct and liquid alternatives. These appeal to asset owners wanting direct co-investment exposure without the full illiquidity profile of traditional direct programs.
What Are the Practical Implications for Asset Owners?
For asset owners with AUM below $5 billion, fund allocations should remain the primary vehicle, with selective co-investment access through manager relationships. The operational and governance burden of a standalone direct program does not justify the cost savings.
For asset owners with AUM of $5–20 billion, a hybrid model is appropriate: 70–80% fund allocations across a curated manager base, and 20–30% direct and secondary exposure, sourced opportunistically or through formal co-investment partnerships. This minimizes operational overhead while capturing material fee savings.
For asset owners exceeding $20 billion, a full direct program becomes justifiable. Tier 1 institutions (CalPERS, Teacher Retirement System of Texas, Norwegian Government Pension Fund Global) operate dedicated direct investing teams and actively manage both fund and direct allocations, using manager relationships and operational expertise to drive superior risk-adjusted returns.
The governance question extends beyond performance. Key Events and Conferences for Asset Owners in 2026 will continue to focus on operational governance, fee structures, and direct program benchmarking as asset owners refine allocation methodologies in response to fee pressure and performance expectations.
Final consideration: the choice between direct and fund investing is not binary. Leading institutions deploy both, using fund allocations as a stability anchor (diversified, professional management, predictable fee structures) and direct programs as a return enhancer and governance tool. The appropriate balance depends on institutional AUM, risk appetite, operational capacity, and board-level conviction about in-house investment expertise.