Michael Trihy, CFA, CAIA, Director and Portfolio Manager at Bow River Capital, joined Keith Black, Managing Director at RIA Channel, to discuss the growth and strategies of evergreen private equity (PE) funds.
Over the last few years, evergreen private markets fund activity has grown significantly, moving from approximately six funds in 2020 to dozens of funds today. There is growing interest from individuals who must invest for their retirement without relying on defined benefit pension funds.
Historically, private fund flows have been dominated by institutional investors. However, those investors have allocated little to private assets in the last two years because the 2022 declines in stock and bond prices left them overweight in private market assets. Fund managers, or general partners (GPs), are looking to increase fundraising from individual investors during weak demand from institutional investors.
Evergreen PE funds often focus either on secondary funds or a co-investment strategy. LPs acquire interests in fully invested PE funds from another LP in secondary funds. Buyers can typically purchase secondaries at a discount, with transactions often occurring four to six years into the fund’s life. Funds following a secondary strategy can invest large sums of capital, with returns coming quickly but with a lower total return and internal rate of return.
In contrast, co-investment funds invest directly in private companies alongside a general partner without paying any management fees or carried interest. Co-investment strategies are more complex, and it takes longer for the companies to mature to higher valuations. These funds can’t invest large amounts of capital quickly but may offer higher potential returns that could have different performance outcomes than secondary funds due to a lower fee drag.
The most popular evergreen structures are tender-offer funds and interval funds. While tender-offer funds allow GPs greater discretion on liquidity and valuations, interval funds have stricter rules. Interval funds tend to have investor-friendly structures, including daily subscriptions and the ability to trade on a mutual fund platform. Operating outside of the 1940 Act structure can offer GPs additional flexibility.
2023 was difficult for the private equity market, with exit activity down 60% from 2021 and fundraising activity declining toward the levels seen during the Global Financial Crisis (GFC). Raising new money for PE can be difficult when funds from prior vintage years have slow exit activity. These can lead to GP-led continuation vehicles and seasoned primaries. GP-led continuation vehicles sell assets from an older PE fund into a newer PE fund, providing liquidity to existing investors with assets raised from investors in the newer fund. This allows the GP to maintain attractive assets for a longer holding period without being forced to exit in the current environment. These funds have evolved over the last three years, with fees and alignment of interests becoming more LP-friendly.
GPs, who have yet to meet their fundraising goals years into the fund’s life, offer seasoned primaries. Investors may be able to buy into the fund at par even though the fund’s portfolio companies may have appreciated 40% or more since the fund’s investment. This could impact the returns to LPs by more than the discounts offered when purchasing secondary fund interests.
Funds from recent vintage years experienced relatively low fundraising levels, which may potentially enhance co-investment opportunities for the next two to three years.
Resources:
Bow River Evergreen Strategies
An evergreen fund is a type of investment fund that has an indefinite life span and continuously raises capital rather than having a predetermined fundraising period and lifecycle, as do traditional private equity or venture capital funds.
Investing in secondary private equity funds involves risks, including the potential for the underlying assets to underperform and liquidity issues that may affect the ability to sell investments at desired times or prices. Purchasing secondary fund interests at a discount does not guarantee a profit. Lower total returns and internal rates of return (IRR) can impact overall investment performance. Private equity investments are subject to market volatility, potential loss of principal, and are generally illiquid, meaning they cannot be easily sold or exchanged for cash.
For Registered Representative Use Only. Not to be used with the general public.
6717196.1