Asset owners choose between direct investing—acquiring assets individually for control and lower fees—and fund investing through managers for diversification, expertise, and operational efficiency. The optimal approach depends on scale, capability, and portfolio complexity.
Direct investing—purchasing assets without fund intermediaries—and fund investing each serve distinct roles in institutional portfolios. Asset owners typically employ both, balancing fund access to diversification and professional management against direct holdings' potential for fee reduction, operational control, and alignment with specific mandates such as climate objectives or geographic priorities.
What Is the Structural Difference Between Direct and Fund Investing for Asset Owners?
Direct investing means acquiring assets—equity stakes, real estate, infrastructure, or debt instruments—on behalf of the asset owner's portfolio, either through wholly owned subsidiaries or alongside co-investors. The asset owner retains full operational and governance involvement.
Fund investing involves committing capital to limited partnerships, commingled funds, or collective vehicles managed by external fund managers. The asset owner becomes a limited partner (LP), ceding day-to-day decision-making to the general partner (GP).
The governance implications are material. CalPERS, with $458 billion in AUM as of 2024, structures its private equity program across both channels. Its directorship seats in portfolio companies provide board visibility unavailable to pure fund LPs. Conversely, CalPERS allocates substantial capital through external private equity partnerships to access specialized expertise and geographic reach it cannot replicate internally.
The Norwegian Government Pension Fund Global (Norges Bank Investment Management), managing $1.32 trillion, employs a hybrid model. Its direct real estate holdings—via 100% ownership stakes in major European properties and retail centers—coexist with co-investments in major real estate funds managed by partners such as Brookfield and Blackstone. This duality allows Norway to both control assets aligned with its climate transition criteria and maintain exposure to diversified property markets through professional intermediaries.
How Do Fees and Economics Differ Between the Two Approaches?
Fee structures represent the most immediate economic distinction. Direct investing eliminates management fees and performance fees otherwise paid to GPs—typically 2% per annum plus 20% carry for private markets funds. For a $1 billion private equity allocation, this differential compounds significantly over a 10-year hold.
However, direct investing imposes internal costs often underestimated: dedicated investment teams, legal counsel, compliance infrastructure, and operational due diligence capabilities. These costs are fixed or semi-fixed; they do not scale proportionally with portfolio size until an asset owner reaches substantial scale.
The California State Teachers' Retirement System (CalSTRS), with $305 billion AUM, maintains an in-house infrastructure for direct real estate and infrastructure investing. Its internal team cost—estimated at 15–20 basis points of AUM for those portfolios—remains substantially below external fund fees, but requires institutional scale and long-term commitment to justify.
For mid-sized or smaller asset owners—regional pension funds or endowments with $10–50 billion AUM—the mathematics favor fund investing. The fixed cost of internal infrastructure becomes a larger drag on returns. The University of Michigan's endowment ($15.9 billion as of 2024) maintains a lean direct investing operation focused on follow-on investments and co-investments alongside external managers, rather than proprietary deal sourcing.
Fund investing also distributes operational risk. If a direct real estate holding enters distress, the asset owner must manage the crisis. Fund LPs delegate this risk to the GP.
What Are the Performance and Control Trade-offs?
Direct investing offers potential for outperformance through operational value creation. When an asset owner or its co-investor cohort can actively improve asset management, this adds return independent of market appreciation. Infrastructure assets—toll roads, utilities, renewable energy facilities—are common targets because operational efficiency improvements translate directly to cash flow.
Abu Dhabi's sovereign wealth vehicle Mubadala Investment Company ($284 billion AUM) pursues direct infrastructure investments with deep operational engagement. Its stakes in renewable energy projects in the United States and Europe allow board-level influence over capital allocation and technology adoption decisions that a passive fund LP cannot exercise.
Conversely, direct investing concentrates risk and requires conviction. An asset owner betting capital on a single infrastructure project or a minority stake in a manufacturing facility accepts idiosyncratic risk that diversified funds mitigate across dozens of holdings.
Fund investing provides instant diversification. A $500 million commitment to a generalist private equity fund typically gains exposure to 25–50 portfolio companies across sectors and geographies. Direct investing at equivalent scale delivers far less granularity unless the asset owner is sufficiently large to source and manage multiple direct deals simultaneously.
The Swedish national pension funds (AP1–AP7), collectively $200 billion AUM, employ both strategies. AP2 and AP4, the larger vehicles, maintain direct stakes in European utilities and real estate. AP1, with $38 billion, relies more heavily on fund partnerships for private markets exposure due to economies of scale in its size band.
How Does Liquidity Differ Between Direct Holdings and Fund Commitments?
Direct assets typically exhibit lower liquidity than fund positions. A wholly owned subsidiary or minority stake cannot be "exited" on a quarterly or annual basis. The asset owner must execute a secondary sale, arrange a sponsor-led continuation fund, or wait for an organic exit event—sale to a financial sponsor, IPO, or dividend recapitalization.
This illiquidity is intentional and acceptable for endowments, sovereign wealth funds, and long-dated pension plans with liability horizons of 20–30+ years. The endowments of Harvard ($50.9 billion, 2024) and Yale ($41.4 billion, 2024) hold significant direct real estate and operating company positions precisely because their indefinite time horizons accommodate illiquidity.
Fund commitments carry standardized liquidity profiles. A private equity fund has a stated vintage year, expected J-curve, and projected exit window (typically 10 years). This structured approach suits liability-driven investors who must forecast cash needs.
However, fund liquidity is not immediate. An LP seeking to exit a mid-vintage fund holding typically must either wait for fund distributions or sell its position on the secondary market at a discount—typically 10–20% below NAV depending on market conditions.
The distinction matters for portfolio construction. Asset owners with volatile cash flows or uncertain future commitments should weight fund structures. Those with stable or predictable liabilities can accept direct investing's illiquidity in exchange for better economics and control.
What Governance and Oversight Capabilities Do Asset Owners Gain Through Direct Investing?
Direct investing provides board seats, information rights, and governance participation unavailable to fund LPs. For asset owners with specific mandates—climate transition, biodiversity impact, or specific ESG criteria—this control is material.
As explored in Physical Climate Risk for Asset Owners, asset owners increasingly screen holdings for stranded asset exposure and climate vulnerability. A board seat on a direct real estate holding allows the asset owner to influence capital allocation toward climate resilience. A fund LP submits scorecards to the GP and hopes the fund's strategy aligns with the LP's thesis.
The UK's £180 billion Local Government Pension Scheme (LGPS) pooling model combines fund investing (through externally managed equity and bond mandates) with direct infrastructure investing, where local authority pools co-invest alongside external managers in renewable energy and transport infrastructure. This hybrid approach allows LGPS pools to embed their net-zero commitments into asset-level governance while maintaining diversified exposure through fund partnerships.
Board participation also enables granular due diligence alignment. As detailed in Private Markets Due Diligence: A Framework for Asset Owners, institutional investors need rigorous processes to assess operational risks, management quality, and capital structure. Direct involvement accelerates this learning.
When Should Asset Owners Choose Direct Investing Over Funds?
Direct investing is optimal when an asset owner meets specific conditions:
Scale and sustainability. The asset owner has sufficient AUM to justify a dedicated investment team and infrastructure—generally $30 billion+ for broad private markets programs, lower thresholds for single-asset-class specialization (e.g., real estate).
Clear conviction and expertise. The asset owner or its partners possess operational or market expertise that adds demonstrable value. This is most evident in infrastructure, real estate, and select operating companies.
Mandate alignment. The asset owner's governance requirements, ESG criteria, or strategic focus mandate asset-level control. Digitisation as an Investment Theme for Asset Owners exemplifies a niche mandate where direct stakes in software platforms or digital infrastructure allow customized governance aligned to digital transformation theses.
Long-term capital. Liabilities or endowment status support extended holding periods (10+ years) without liquidity pressure.
Geographic or sectoral depth. The asset owner targets specific geographies or sectors where it has or can build proprietary sourcing networks.
The Canadian Pension Plan Investment Board (CPP Investments), managing $646 billion, pursues substantial direct investing in infrastructure, real estate, and credit. Its size, long-term liability matching, and in-house capability justify the infrastructure investment. Smaller provincial pension plans in Canada, by contrast, allocate to CPP Investments' funds and co-investment vehicles, gaining exposure to CPP's direct holdings with lower overhead.
When Should Asset Owners Prioritize Fund Investing?
Fund investing is appropriate when:
Limited AUM or bandwidth. The asset owner lacks the scale or personnel to justify in-house infrastructure.
Diversification needs exceed conviction. The asset owner seeks broad exposure across sectors or geographies without specific operational value-add.
Liquidity requirements demand it. Liabilities or withdrawal patterns require more structured exit timelines.
Expertise concentration is risky. The asset owner cannot source and manage multiple direct deals of quality simultaneously.
Co-investment capacity is low. The asset owner cannot commit incremental capital to co-invest alongside GP deals, which limits its ability to influence economics or governance.
For smaller endowments—$500 million to $5 billion—and many corporate pension plans, fund investing remains the predominant private markets channel. The University of Pennsylvania's endowment ($21.5 billion, 2024) allocates substantial commitments to external private equity and real estate funds, with direct investments playing a secondary role in follow-ons and co-investments.
What Role Does Fund Finance Play in the Direct vs. Fund Decision?
Fund finance—credit facilities extended to funds and their LPs—has expanded the hybrid landscape. Fund-level subscription credit lines and continuation funds financed through fund finance vehicles allow LPs greater flexibility in managing commitments and exit timing.
For instance, an LP that has committed to a 2016-vintage private equity fund approaching year 9 can access secondary fund finance to defer its exit, reducing pressure to sell into an unfavorable secondary market.
This innovation softens the traditional dichotomy. Asset owners can use fund finance structures to extend fund exposure—mimicking some liquidity benefits of direct investing—while maintaining the operational delegation and diversification of fund partnerships.
How Do Asset Types Influence the Direct vs. Fund Choice?
Different asset classes exhibit distinct direct-to-fund ratios for institutional investors.
Real estate: Strong direct investing presence, particularly for core-stabilized assets. Many large asset owners (CalSTRS, Norges Bank IM, endowments) maintain substantial direct real estate holdings. As covered in REITs vs Direct Real Estate: Which Is Right for Institutional Investors?, direct ownership provides control over tenant relationships, capital allocation, and Physical Climate Risk for Asset Owners assessment that REIT or fund structures limit.
Infrastructure: Large asset owners pursue direct stakes in utility concessions, renewable energy, and toll roads. The stable cash flows and long-term nature of infrastructure align with direct investing's liquidity profile. Smaller asset owners rely on infrastructure funds.
Private equity (buyouts): Primarily fund-based, with direct investing limited to larger asset owners engaging in add-on investments, recapitalizations, or continuation fund participation. The operational complexity and fast-moving deal environments favor professional GPs.
Credit and debt: Fund structures dominate, particularly for illiquid credit. Direct debt investing is concentrated among larger asset owners in specific niches (project finance, structured credit).
Implications for Long-Term Allocators
The direct vs. fund choice is not binary. Institutions should construct a portfolio that leverages each channel's strengths. Large asset owners (CalPERS, Norges, CPP) employ both extensively, achieving fee savings through direct holdings where scale justifies infrastructure, while accessing diversification and specialty expertise through funds.
Mid-sized asset owners should assess whether direct investing's marginal economics justify the infrastructure cost, focusing direct capital on niche areas where conviction and expertise are highest, while funding broader exposures through partnerships.
Smaller asset owners should default to fund structures unless a specific mandate—impact investing, climate transition, geographic focus—demands direct governance.
Across all tiers, rising complexity in Digitisation as an Investment Theme for Asset Owners and climate risk assessment increasingly incentivizes direct board participation, even for smaller allocators. Co-investment structures—investing alongside funds in specific deals—offer a compromise, combining fund partnerships with asset-level governance.