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For the largest, most sophisticated sovereign wealth funds, working with external asset managers is an option, not a necessity — and the balance of power has shifted unmistakably. Nowhere is that more evident than in alternative-asset classes like private equity, infrastructure and real estate. In the aftermath of the global financial crisis. sovereign wealth funds, which have the ability to insource, are less willing to pay traditional private equity fees that typically include a 2 percent asset management fee and a 20 percent incentive fee known as carry. (See also “ Sovereign Wealth Funds Look for Inside Edge by Managing Money In-house ”)

At the same time, sovereign wealth funds are still eager to partner with the private equity and infrastructure managers they perceive to be best in class. The result? A rapidly hybridizing private markets industry in which sovereign wealth funds are actively seeking to coinvest with — or even buy into — the managers that deliver the best risk-adjusted returns.

“How sovereign wealth funds choose to play private equity is going to be interesting because almost every single one of them is larger now than it was in precrisis peak,” says Robert Brown, global head of limited-partner services for Boston-based private equity giant Advent International, which last year raised a new fund valued at €8.5 billion ($10.8 billion), the largest in the firm’s three-decade history. “Why is that? These funds are cash flow–generative. They’re not really paying out to cover liabilities — not like pension funds. They’re simply building up assets.”

Despite Advent’s success in raising capital for its latest fund, traditional inflows into private equity funds have been muted since the financial crisis. In 2008 institutions committed $685 billion to private equity funds (including real estate and infrastructure), according to London-based market research firm Preqin. The following year the total committed capital was more than halved, to just $318 billion. It fell even further in 2010, to $290 billion, before starting to recover: In 2012 the total capital committed to private equity funds hit $365 billion.

Nonetheless, private equity firms are reporting a surge in interest among their limited partners for co-investments; essentially, their investors are looking for opportunities to deploy at least an equal amount of capital directly alongside their private equity managers without incurring fees. When such deals are struck with their general partners, sovereign wealth and pension funds can, in effect, dilute their fee loads and reduce the cost of their private equity portfolios. By making co-investments — and an increasing number of direct investments — sovereign wealth funds can also create custom portfolio weightings independent of any specific fund.

“I see this trend toward direct investing as a continuous, long-term development,” says Martin Halusa, CEO of London-based private equity firm Apax Partners. “I think it started off with co-investments in which these funds had the insurance policy of knowing that the most experienced guys in the market were on their side. But as they gain more confidence, I think they’re shifting the weightings.” In the earliest stages of the postcrisis co-investment trend, Halusa says, some of the most autonomous sovereign wealth funds were seeking to deploy 80 percent of their private equity allocations in co-investments and 20 percent in direct investments. “Now some are running a 50-50 split,” he adds, “and some are even 80-20 the other way around.”

In the past five years, a handful of the largest sovereign wealth funds have even opted to take equity stakes in the general partnerships of their private equity managers — a trend that Halusa knows well. In 2009, Apax sold a total stake of 10 percent of its management company to China Investment Corp. (CIC), Australia’s Future Fund and Singapore’s GIC (formerly Government of Singapore Investment Corp.). The partners used the proceeds from the sale to fund a permanent capital vehicle — a balance sheet from which Apax could increase its future deal commitments as a general partner. “If we perform terribly well, the day may come when we will mainly invest our own balance sheet and invite some institutions to coinvest alongside us if they’re interested,” Halusa explains.

The equity ownership stake taken by the three sovereign wealth funds does not affect the daily workings of the private equity firm. “We’re not a subsidiary,” Halusa hastens to say, “and we’re not a captive. We’re still completely independent.” The Future Fund, CIC and GIC bought into Apax with the understanding that they would not get any preferential treatment or terms, the CEO says, but they do participate in the economics of the general partnership, so when Apax makes money on its asset management and incentive fees, they make money too. But they do not have preferential access to co-investment opportunities. The sovereign funds receive one partnership-style perk: They can get hands-on training.

“They have the right to second one of their young people to work with us and we believe they have found the experience very enjoyable and beneficial,” says Halusa. “Their sector teams often call ours to discuss industries and countries — which is something we’re happy to do with any large investor, but the general partners just seem to use that service more often.”