Private equity investor body sounds alarm on ‘conflict vehicles’

An influential body of private equity investors has said one of the industry’s favoured methods of exiting investments during a dealmaking downturn is so problematic that they should be dubbed “conflict vehicles”.

Buyout firms have increasingly turned to structures known as continuation vehicles — new funds they set up to buy companies from their old funds — to avoid selling them on the open market at undesirable prices and to generate new sources of fees.

But continuation vehicles and the rush by firms to raise money from retail investors were driving increasingly conflicted behaviour by private equity fund managers, according to a top executive at the Institutional Limited Partners Association, which represents some of the world’s biggest pension and sovereign wealth funds.

“Conflicts of interest are one of the biggest points of [buyout firm] behaviour that has shifted in the negative sense,” said Neal Prunier.

“The two big drivers of this are . . . continuation vehicles and retail,” he said. “I would love if continuation vehicles began to be called conflict vehicles.”

Since interest rates started to rise in 2022, private equity managers have struggled to sell holdings to arm’s-length buyers at desired valuations. That has made it harder for them to return cash to their backers and meant they are less able to raise new funds.

Groups have helped solve their fundraising problem by aggressively targeting individual investors instead, enabling them to grow their assets under management even as fundraising from institutions has slowed.

But managers have also increasingly flipped assets to continuation vehicles — often backed by the flood of retail cash — rather than selling them on the open market. Because they sit on both sides of the transaction, there are concerns that they could influence the price and short-change investors in the selling fund.

Valuations of buyout holdings were a particular point of “growing frustration” for many fund backers, Prunier said.

Last year, managers on average sold their holdings below book value, compared with the roughly 20 per cent uplift typical in the past, Prunier said. The fall had been partly “driven by how many exits are [to] continuation vehicles”, he suggested.

When ILPA first put out guidance in 2023 for buyout firms on how to best manage continuation vehicle processes, the body did not expect the explosion in such sales to the point that last year they accounted for a fifth of all buyout exits, he added.

Prunier said some fund investors were concerned that buyout firms were not properly following that guidance.

“There is a rallying cry from our members to move this forward in a very collaborative manner, but with some velocity, because of the increasing and ongoing concerns with continuation vehicles,” he said.

ILPA last year sounded the alarm about the risks of private capital groups prioritising their funds aimed at retail investors over their funds for institutional investors, especially where both were invested in the same companies.