Semi-liquid evergreen funds are increasingly popular but could create challenges for fund managers around liquidity, valuations and fee conflicts, according to Connection Capital’s Claire Madden.
Evergreen funds have grown substantially in recent years, offering greater liquidity to what are typically illiquid assets such as private credit, with lower investment thresholds that open up the asset class to a wider range of individuals.
These open-ended vehicles allow investors to redeem their investments on a more frequent basis than traditional private markets funds, although they are often capped to prevent large outflows.
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There were more than 350 semi-liquid evergreen funds in the US in the third quarter of 2024 with total assets under management of over $380bn (£282bn), and more than half of those were launched within the last four years, according to Morgan Stanley data cited by Connection Capital.
There is the risk of a liquidity mismatch, as the underlying assets are still illiquid although investors are able to withdraw funds, Madden explained.
“Inflows and outflows in these vehicles are volatile, and if everyone decides they want in or out at the same time, that creates serious challenges for fund managers, either when it comes to deploying capital quickly – or worse – when it comes to returning it if redemption requests are made en masse,” said Madden, who is managing partner at the private markets investment firm.
Evergreen funds never close, and could – in theory – operate in perpetuity, with investors continually committing and withdrawing capital.
“Therefore, there is intense pressure to put as much capital as possible to work straight away, as performance is under scrutiny at all times,” she added.
“That can create a lack of discipline around how much managers are prepared to pay for assets.”
There may also be issues around valuations and fee conflicts, Madden added, as fees are based on the net asset value (NAV) of assets, even though this includes unrealised value.
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“The FCA’s recent review of private market asset valuations highlighted that there is the potential for conflicts of interest to occur when fees are charged on a NAV basis,” she said. “By contrast, there is little incentive to inflate valuations in a closed-ended structure as management fees are typically charged on capital committed and carry only paid when assets are finally sold, and their actual value has been realised.
“Further conflicts can arise when exiting assets. In a closed-ended fund, the structure ensures that assets are disposed of in a way that maximises returns within the fund’s lifetime. But in an evergreen structure, the fact that fees are being charged on NAV on an ongoing basis could act as a disincentive to sell the assets, which may not be in investors’ best interests.”
Another potential issue could be cash drag, as a fund may need to keep a high enough level of cash in the vehicle to meet redemption requests, Madden explained.
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She suggested that a solution to these issues could be the hybrid public/private markets funds which are now starting to come on to the market, although these could also present challenges if the balance between the funds’ public and private holdings gets out of kilter and forces a fire sale of private assets.
“Innovative solutions that democratise access to private markets are no bad thing – provided a pragmatic, responsible approach is taken to meeting investors’ needs and protecting their interests.,” Madden said.
“While semi-liquid evergreen private equity structures are tempting, history tells us that actually delivering the promised liquidity when the underlying fund assets are illiquid is fraught with challenges. Whether public/private hybrid funds are a better solution remains to be seen.”
