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Article by By Christen Estrup, Co-founder of Jera Capital
The private markets asset classes have historically been reserved for large institutional investors and closed-ended fund structures were designed to meet the demands of these investors. In recent years the asset class has received increased attention from non-institutional investors who do not have comparable scale, lifespan, and resources. In this article, we argue that open-ended / evergreen fund structures offer strong benefits to non-institutional investors and even to some institutional investors that will benefit from having some level of allocation to evergreen structures.
Background
The typical framework for investingin private markets is based on illiquid closed-ended structures featuring a term of at least 10 years. These structures have the basic advantage that they are cash-in/cash-out structures. This means that capital is called when investments are made and distributed to investors when investments are realized. These structures are well suited for investors who have the means and patience to build and run large scale programs – such as large institutional investors. In comparison, open-ended (“evergreen”) funds do not have a termination date and can accept new investors continuously (usually monthly). Capital is invested in such funds based on a subscription (i.e. the investor invests the full amount at the time of subscription) and investors can redeem their investments in the fund on an ongoing basis. In such structures, investors typically enter and exit the fund at the net asset value prevailing at the time of subscription/ redemption and gain access to a diversified exposure to private markets upon investment.
Simplified access to private markets
The capital deployment pattern ofclosed-ended funds requires the investor to hold sufficient liquidity reserves to meet the unfunded part of the commitment.
While models can be built to estimate this requirement, most investors will end up holding more liquidity than needed, thereby diluting their returns. In evergreen structures, cash management is handled within the fund, and the evergreen fund manager will typically retain some level of cash to manage the cash-flows of the underlying investments, but the investor does not have any direct unfunded liabilities, and the liquidity management is outsourced to the evergreen fund manager. The cash balance of the evergreen fund will somewhat dilute returns but, provided that the evergreen fund manager is able to control capital deployment, the dilution would be limited. It is therefore critical for investors to select an evergreen fund manager that can control the deployment of capital through acquiring assets
in the secondaries market for instance.
As the evergreen fund manager re-allocates distributions received by the openended fund, an investor can maintain its exposure to private markets through a
single subscription, which dramatically simplifies the administration and portfolio management burden on such investor, compared to managing and
expanding a large portfolio of commitments to closed-ended funds. A further benefit is that the cost structure of an evergreen is typically more aligned with the capital at work, as fees in evergreen funds are generally charged based on net asset value of the fund rather than on committed capital as is typically the case in the first years of a closed-ended fund.
A flexible way to build and maintain exposure to private markets
For investors in closed-ended funds, it takes time and effort to reach a desired Private Equity investment level. Additionally, given that some assets are sold early in the life of a fund, investors will often only end up having a maximum of 60-70% of their total commitment deployed at any point in the fund’s life.
To reach a desired level of exposure, an investor therefore needs to undertake an overcommitment strategy, which comes with obvious risks.
On the other hand, investors with no prior exposure to private markets can almost instantly achieve their desired allocation to the asset class by subscribing their desired allocation to an evergreen fund. In a similar fashion, investors who are below their target exposure can also achieve their desired allocation by investing the shortfall amount to their desired allocation into an evergreen fund.
Investors in evergreen funds which are over-allocated can utilize the redemption feature to decrease their exposure. Institutional investors, which typically need to adhere to defined allocation guidelines can therefore benefit from allocating a potentially significant minority of their private markets’ exposure to evergreen fund structures, to enable easy portfolio adjustments in fluctuating markets.
”Investors can almost instantly achieve their desired allocation to the asset class by subscribing to an evergreen fund.”
Overcoming the liquidity hurdle in private markets
Achieving early liquidity has always been a hurdle for private markets investors. While secondary markets have developed significantly, selling still
involves transaction risk, price uncertainty and a significant delay in achieving liquidity. As such, accessing the private markets through closed-ended
structures requires the ability to remain invested for the very long term or the ability and patience to undertake sales in the secondary market.
The evergreen fund structure provides investors the valuable option to redeem their holding in the evergreen, in part or in full, at the reported net asset value
of the fund holdings and within a reasonable timeframe. However, investors should bear in mind that the liquidity option for evergreen structures is an “option” that will only be available under “normal” market conditions and that the liquidity held in the evergreen may not be sufficient in all market conditions (and the fund manager may in some cases need to impose gates and postpone some redemption requests).
Conclusion
In conclusion, we believe that the features of the evergreen fund structure offer a much more attractive package to non-institutional investors than closed-ended structures and that most institutional investors would also benefit from adding some level of evergreen fund exposure to their private markets
portfolios to enable dynamic portfolio adjustments. This is also the reason why evergreen fund structures have seen an increase in popularity in recent years in conjunction with the increasing appetite of non-institutional investors for private markets.
About Jera Capital
Jera Capital is an independent private markets asset manager that offers flexible investment solutions to a wide group of investors (both institutional and non-institutional). The Jera Capital team has over 45 years of combined experience in private markets and its members have been active in the secondary market since 2006 and have managed evergreen fund structures since 2008.
More Information: www.jera-capital.com
