Evergreen funds

One size does not fit all

Not too long ago, the alternatives world was neatly divided into two distinct types: hedge funds and private capital funds. Each type focused on different parts of the investible market (public securities vs. privately held assets) along with their own liquidity terms, legal structure, and investor reporting requirements. To this day, these are called open-end funds (funds with periodic contribution and redemption opportunities favored by most hedge funds) and closed-end funds (drawdown-based structures with fixed terms and end-of-life characteristics typical of most private capital managers).

A funny thing, though, happened in the alternatives industry in the past few years—managers and investors began to realize that a “one-size-fits-all” fund structure does not work for all LPs—and even for some managers. 

What are evergreen funds?

Evergreen funds (sometimes called hybrid, long-held, or perpetuity funds) share characteristics of both open-end and closed-end funds. Open-end funds have no terminal date and can accept investors’ contributions on a periodic basis with preset intervals for investors to withdraw capital. Closed-end funds, on the other hand, have a defined life span with no withdraw rights in a commitment/drawdown structure. In a closed-end fund, fundraising occurs when a new fund is launched, but in an evergreen fund structure, the manager is always in fundraising mode. For investors that opt to have any disbursements or principal reinvested, an evergreen fund will have the opportunity for any generated income to be applied to new or existing investments—particularly useful for yield-producing strategies such a private credit or real estate (Figure 1). Cash management is another important consideration in an evergreen vs. closed-end structure as the manager will need to balance flows into and out of the fund in due consideration of the fund’s liquidity terms. For private equity funds used to having capital secure over the life of the fund, this becomes one of the biggest challenges managers face with a semi-liquid structure.

Gaining traction in the market

Managers across private capital markets are increasingly offering evergreen funds to both retail and institutional investors with the format gaining steady traction over the past 12 years (Figure 2).

Evergreen fund offerings also cut across geographies, although still dominated by North American and European managers (Figure 3). The majority of firms that have embraced evergreen funds, though, are still dominated by larger GPs that have the operational infrastructure to handle the complex accounting and reporting needed to service this type of structure. As previously stated, yield-producing assets have seen the biggest adoption of evergreen funds, which coincides with the growth and maturation of the private debt and direct lending space as new investors look to make their first allocations to the strategy. It also allows the investor to maintain adherence to allocation targets (and stay fully invested) through continual reinvestment of principal and interest without having to underwrite and conduct due diligence on another fund. 

Investors like the flexibility of evergreens

Having more liquidity options is perhaps the biggest reason investors would be attracted to an evergreen fund. Certain sophisticated institutional investors might favor the traditional closed-end fund if the strategy is perceived to benefit more from a long-term lockup versus a semi-liquid structure. Some institutional investors might also prefer their investments not to be commingled with “retail” money given potential differences in investment horizons.

Having additional investment and redemption rights in a private capital strategy, though, provides additional benefits for investors of all types as cash flows can be better managed outside of a traditional commitment/drawdown/distribution scenario, which makes pacing and allocation decisions easier. This can also reduce any potential cash drag for the investor as the capital is fully invested at all times. At the end of the day, though, it’s the flexibility to add and withdrawal capital outside of a 10-to-12-year lockup that is going to propel investors to an evergreen model.

Potential benefits for investment managers

For GPs looking to raise capital outside of the traditional fundraising cycle and expand their potential investor base, evergreen funds offer a compelling opportunity—but not without some important caveats. Managers can potentially open up the universe of investible assets with the removal of a multiyear lockup found in traditional closed-end funds, tapping into a pool of assets already bound by existing liquidity constraints in other commitments. 

In addition, as private capital managers look to the UHNW/RIA market to expand their pool of potential investors, evergreen funds become an attractive option for an investor base unfamiliar and uncomfortable with having an investment tied up for 10-plus years. It should be noted though, that the “democratization” of private capital strategies to the retail market comes with its own challenges given the potential for less “stickiness” in this investor base in addition to liquidity needs and time horizons that are often very different from institutional investors.

An additional benefit for managers is the ability to better manage “end-of-term” investments and avoid the forced exit conundrum at the end of a fund’s life. Certainly, side pockets and continuation funds are options, but these, of course, entail getting approval of the LP base along with the cost and effort of setting up these options. An evergreen fund structure allows the manager the flexibility to make new or add-on deployments as opportunities arise without having to contend with time limits and constraints.

The right partner is vital to success

Given the opportunity to attract a wider pool of investors, why wouldn’t every manager with a private equity or debt strategy want to offer an evergreen fund option? The simple answer is that running an evergreen fund, from an operational perspective, requires a significant step-up in operational capabilities for a GP. Offering a more liquid, perpetual version of a fund adds multiple layers of complexity across the entire firm, both in the back office and with the investor relations team. NAVs, onboarding, KYC/AML, redemptions, investment performance calculations, fee and carried interest calculations, reporting, and money transfers all compound significantly when more liquid options are introduced. Even more so if the fund will be offered to the non-institutional market. The simple fact is that with more transactions, more NAVs to strike, and more reporting that needs to be accomplished, the risk for error elevates. The need for establishing proper controls, workflows, and automation cannot be overstated. How those processes are created and who oversees them will serve as the foundation to be able to take an evergreen fund to market and manage it successfully. Choosing the right partner—one with substantial experience in helping administer evergreen-type structures—can go a long way to ensuring the successful rollout and management of offering this type of product to the market.

All data used in this article has been sourced from Prequin 2023.