Asian private equity firms use controversial route to exit investments
‘Continuation funds’ gain popularity amid subdued market for initial public offerings
The subdued market for initial public offerings in Asia is prodding private equity investors in the region to pursue a controversial strategy for exiting investments: selling assets to so-called continuation funds they raise themselves.
Five continuation funds closed in Asia last year, the most in a year since 2010, according to data from Preqin, and dealmakers say interest in creating more of the vehicles is rising, particularly in China.
“We have received many, many requests from the Chinese players,” said Won Ha, head of Singapore and South Korea for French private equity firm Ardian, which recently invested in a DWS continuation fund focused on infrastructure.
Private equity firms face pressure to sell their holdings because they raise money from their investors for set periods of time, typically up to 10 years. To lock in profits, they sell their holdings through initial public offerings or to other investors.
The IPO option has become more difficult because of challenging market conditions in places such as Hong Kong and China. “The equity markets, especially in Hong Kong and China, are very poor,” said a private equity manager who has been raising capital in Asia for a single-asset continuation fund.
The problem with continuation funds is that the firms involved are in effect sellers and buyers of the same assets, raising the question of how they can arrive at fair prices for such transactions.
One senior deal adviser at a global consulting group said private equity managers can put off the recognition of losses by selling investments to a continuation fund rather than listing them on public markets. Continuation funds typically last for seven years, dealmakers said.
“At best, there’s an appearance of a conflict of interest. At worst, there is a real conflict of interest,” said Rodney Muse, managing partner at Malaysia-based Navis Capital, which in 2021 closed a $450mn continuation fund with investments in five companies. In 2022, it sold one of those holdings, TES, a battery recycling group, to South Korea’s SK ecoplant for $1bn.
To manage conflicts, Navis solicited bids for its assets from 50 institutional investors and used the best one as the price for sales from its original fund to its continuation fund, Muse said. Investors in its original private quity funds, known as limited partners, had to live with the results, he added.
“It was still a discount — that’s the harsh reality,” Muse said. “There’s a whole lot to it to make sure that it doesn’t tarnish your brand, and that you really are looking after the [limited partners].”
To increase the appeal of continuation funds, managers also tend to lower their fees and commit more capital than they would in a typical fund “so there’s a strong alignment of interest”, said Jan Philipp Schmitz, executive vice-president at Ardian.
Hamilton Lane, a US private equity firm that has been a lead investor in at least three Asian continuation funds totalling $830mn since 2020, said it avoided being both a seller and buyer of the same underlying asset, according to Mingchen Xia, co-head of Asia investments. The three continuation funds include two managed by the Chinese group Legend Capital and one by US-based L Catterton.