By John L. Bowman, CFA, Chief Executive Officer, CAIA Association
I have spent the last six weeks largely on the road in Europe, Asia and parts of the United States. While certainly not the only topic or purpose for the Magellan style Autumn swing, the pulse of the global industry is undoubtedly centered on evergreen funds. I spent time discussing EQT’s launch of the first Asian PE fund, Swiss private bankers’ challenge in explaining the private credit whirlwind, and the Japanese regulator trying to calibrate capital formation with investor protection. While they take on different forms in various markets, the structural trade-offs, communication challenges, and fundraising velocity were ubiquitous: evergreens are everywhere.
This is certainly not an accident. CAIA has been an agent for this global dialogue with our recent seminal report followed by a micro-credential on our flagship online platform CAIA.nxt. Our message remains steadfast: while evergreen products can effectively provide broader access to private capital, there are still design shortcomings, bugs, and flawed product positioning. Just as with any first vintage software product, the industry needs to provide a “patch” that resolves some of the outstanding issues.
Here were my three main takeaways from my recent travels:
1. What’s in a name?
One of the headline recommendations of our report: The Window Narrows: Evergreen Funds and the Choice Before the Industry, is a formal retirement of the phrase “semi-liquid.” Vocabulary matters. Words are powerful. When “semi” occupies a cultural meaning of regular, reliable, half the time etc., it misstates the purpose and reality of the embedded liquidity mechanisms. We must remember that limiting redemptions is a positive feature of the hybrid structure that invests capital in illiquid companies, assets, and loans. It is in all stakeholders’ interest to minimize and manage cash flows to avoid forced selling (likely at a discount) of underlying holdings. As we wrote in the report, terminology is often the only element that survives the pitch deck and advisor communication: lexicon is much more than cosmetic here.
The good news is that the misleading nature of this phraseology seems to be universal. Both a Zurich private bank and a Hong Kong based GP told me they have recently outlawed the language. This is great news. However, exclusion of a bad naming convention must be replaced by something more effective and genuine. In both cases, when asked, they are using “evergreen” itself as the new label. While this can serve as a general category label for product innovation, this is a poor replacement for client discussions as it’s not descriptive of the core identity of the structure. Frankly, it comes across as a suboptimal anesthetic versus a solution. We have suggested labels such as “liquidity capped,” or “liquidity constrained.”
2. These are not the cash flows you’re looking for
Much ink has been spilled, mostly alarmist, on managing the redemption requests out the back door. This is perfectly understandable as we are test driving the structure, and client poise, for the first time during economic and technological uncertainty. My colleague Georgina has written extensively on this misunderstanding, most notably here. But, very few are talking about the implications of cash flows pouring through the front door during a more sanguine stage of the cycle. To me, this is just as important a debate with more significant implications.
One advantage of the traditional draw-down fund is fundraising occurs periodically, commitments are made, and then the GP calls the capital as investment opportunities arise. This timing alignment of available capital and investment conviction ensures discipline of due diligence and steady pacing. Cash only is put “in the ground,” when the investor identifies a compelling reason to deploy it.
In an evergreen structure, the manager has no such luxury, and the timing alignment breaks down. Capital must be put to work as inflows dictate or the manager risks a material cash drag. A Boston private credit manager with outstanding performance recently told me they have refused to launch an evergreen alternative for fear of short-circuiting their deliberate investment process; “It’s just not worth the hassle and I don’t want to be rushed.” Similarly, in Singapore, a principal at an evergreen African infrastructure fund expressed that they are struggling to find adequate projects to invest in to meet the demand of the subscriptions. This mismatch concerns me, and is one to watch as the space matures. If evergreen performance begins to lag their traditional brethren due to abbreviated and frenzied due diligence, perhaps some form of gates on the front-end are worth considering. All of this can be summarized by the reality that when you stuff illiquid assets into a liquid wrapper, there will be inevitable growing pains; life always finds a way.
3. Who’s the client, again?
As we stated at the beginning, CAIA has always been supportive of all long-term investors responsibly having access to as many “alternative” options as possible in building portfolios. Evergreen structures were meant to be a mechanical breakthrough for the high net-worth and mass affluent demographic to finally gain admission to risk premia previously reserved for institutional and ultra-wealthy investors. And of course, the traditional draw down fund would remain fit for purpose for large asset owners, right?
Maybe not. Both a London-based consultant and Hong Kong private bank shared that institutional investors, from sovereign wealth funds to large family offices were increasing their utilization of evergreen structures. When pressed whether this was simply a short-term proxy for their private capital commitments until calls begin knocking, the response was that, on the contrary, these are permanent allocations. In many cases, they said, allocators are using a “core and satellite” approach where the evergreen funds serve as their standard beta allocations to various private asset classes while draw-downs are used for more alpha rifle shooting to pursue specific sectors, themes or geographies. In some cases, the “anchor” investors of newly launched evergreen funds are large institutional players. These use cases are fascinating and clearly a migration from the industry’s conventional wisdom. This development, if it accelerates beyond the anecdote, could have profound effects on the velocity and source of capital formation going forward.
We’re keeping a close eye on the space and look forward to continued dialogue with all of you.
See you out there.
