Continuation funds take center stage

What asset owners need to know about the vehicle type and its recent rise

A new option in an uncertain market

The ups-and-downs of the public and private markets in recent years have created unique opportunities and challenges for private fund managers (GPs). Sustained demand for private markets strategies from institutional investors has helped GPs raise larger funds in record time. But while GPs are flush with dry powder in their freshly closed funds, market volatility and general uncertainty in today’s public markets has meant that their maturing vintages are struggling to find suitable exit opportunities.

This perfect storm has helped contribute to the rising popularity and utilization of continuation funds.

What are continuation funds?

Continuation funds allow GPs to sell top-performing assets from a previous fund to their own newly formed fund vehicle, rather than accept a lower price via the public markets or M&A when market conditions are not optimal. In recent years however, continuation funds have increasingly become single asset vehicles that serve as a secondary market transaction. According to data from GCM Grosvenor, “Single asset continuation fund transactions represented 48% of GP led transactions in 2021, up from 31% in 2020.”

With the move, GPs can offer liquidity to the investors in the initial fund vehicle while retaining control of valuable assets during poor selling environments. Another rationale for transitioning an asset to a continuation fund is that its investment profile may no longer match the strategy mandate of the initial fund.

Continuation funds also are sometimes positioned as “best ideas” funds where the GP commits additional capital to a collection of high performing assets from previous funds.

What asset owners need to consider before committing to a continuation fund

1) Fees

The biggest factor that institutional investors must consider when evaluating a continuation fund is its fee structure. Generally, continuation funds will charge investors lower fees than a standard private markets fund, often only a performance fee over a hurdle rate. However, investors should be wary of the fees they are charged for the sale of the asset(s) from the initial fund to the continuation fund. According to Financial Times, “Selling companies in an older fund to a continuation fund lets the buyout group revive the flagging fee base. The new vehicle charges fees as a proportion of the amount it invested in a company — invariably a higher sum than the older fund paid.”

­These transactions can be highly complex, and existing LPs should be pay close attention during fee negotiations to ensure that they are not overpaying when allocating to continuation funds. As highlighted in their July 2022 illiquid assets update, sourced from eVestment Market Lens, PERA of New Mexico took the pragmatic step of adding continuation fund language to their side letter agreements to require transparency and disclosure from GPs.

2) Opportunity Cost

Private markets fundraising cycles that were once 3-5 years in duration have shortened to 2-4 years and many institutional investors are being forced to pass on re-ups to existing managers due to pacing plan constraints. As more GPs begin to offer continuation funds, investors will have even more to consider. While continuation funds ensure continued access to stronger performing assets, investors must decide whether any additional upside of these assets are worth the tradeoff of the potential upside for a net new fund.

Another opportunity cost investors must consider is the value of their legacy fund interests on the secondaries market via LP-led transactions. Secondary markets have heated up in recent years as LPs seek liquidity and fund managers chase compelling investment opportunities.

3) Risk

Investing in a mature asset via a continuation fund is not without risks. Buying a proven winner also means most of the value is already priced in and further upside may be limited. Investors must consider if the price offered by the GP via the continuation fund is in line with its fair market value. Additionally there is concentration risk, especially if the continuation fund is a single asset vehicle. 

The investment horizon for the asset is also shorter given its maturity and this must be considered when projecting its potential future value. Investors must bake all these factors into their analysis, a process that is in some ways more complex than simply analyzing a GPs full track record before considering a commitment to a net new fund.

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Nasdaq eVestment delivers transparency and decision support with comprehensive institutional data and powerful portfolio analytics. 

Learn more about how we support asset owners throughout the investment lifecycle, including when they are making decisions between continuation funds or new commitments.

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Andres Ramos

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Andres Ramos is a specialist at Nasdaq focused on the world of institutional investing.

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