Written by: Alex Da Costa
Over the last decade or so, private markets, like private equity and real estate, have been gaining traction with families looking for compelling returns and ways to diversify their portfolios beyond just public equity and fixed income. Historically, accessing these less liquid assets mostly happened through traditional closed-ended funds. But the private markets are evolving with the rapid emergence of evergreen funds (or “open-ended funds”). These offer a more adaptable structure designed for greater flexibility and accessibility. In this piece, we will discuss the advantages and disadvantages of both, exploring why evergreens are booming and how our families should think about using both of these structures in their portfolios.
The Two Fund Structures
Evergreen funds are characterized by their flexible, perpetual nature, meaning they continuously raise and invest capital without a predetermined end date. A defining feature is the periodic liquidity they offer investors, typically through subscription and redemption windows, often monthly or quarterly. This stands in stark contrast to the multi-year capital lock-up typical of traditional closed-end funds. What’s more, evergreen funds usually feature lower investment minimums (sometimes as low as $25,000), making private market investments accessible to a much broader range of investors compared to the multi-million dollar requirements of many traditional closed-end funds. Upon investing, capital in an evergreen fund is typically fully deployed, providing investors with immediate exposure to a diversified portfolio. The pricing of these funds is generally based on the net asset value (NAV) of their underlying holdings, calculated regularly. The increased flexibility provided by these structures allows investors to adjust investment exposure over time with greater precision than traditional closed-ended funds. Evergreen funds are essentially designed to tackle the traditional challenges of accessing private markets: high capital requirements and illiquidity.
Traditional closed-ended funds, in the context of private market investments, are defined by their fixed term and a finite pool of capital raised during an initial fundraising period. These funds typically have a lifespan of around 10 to 12 years for private equity, venture capital and real estate. A fixed capital base is established during a limited fundraising window, usually lasting between 12 and 18 months. The committed capital from investors is then drawn down over approximately 3 to 5 years as suitable investment opportunities are identified. Distributions of investment profits are made at the fund manager’s discretion as the underlying investments are realized and exited, usually towards the later stages of the fund’s life. Performance fees for closed-end funds are commonly structured as carried interest, a percentage of the realized profits that exceed a predetermined hurdle rate, creating a strong alignment of interest between the manager and investors. Historically, this structure has been the dominant vehicle, particularly favored by institutional investors, prioritizing investment discipline and a long-term focus on value creation over immediate liquidity.
Investor Advantages: A Comparative View
Evergreen funds offer several compelling advantages. Their periodic liquidity provides investors with the flexibility to redeem at predetermined intervals, a significant contrast to closed-end funds’ long lock-ups. This enhanced liquidity means more active control over portfolio management and access to capital when needed. The lower investment minimums open up private market access, allowing more investors to participate. Another key benefit is the immediate capital deployment, bypassing lengthy capital call processes and potential “cash drag.” The absence of the J-curve effect (where initial returns for the first few years are often negative in closed-ended funds) and the continuous reinvestment of distributions are also attractive features. Some recent research has suggested that this compounding effect might mean evergreen funds are able to deliver total returns equivalent to their closed-end rivals. The jury is out on this until there is more data to draw comparisons from.
Traditional closed-end funds present distinct advantages, primarily through the strong alignment of interests between the fund manager and investors, driven by the carried interest model. The fixed term encourages a patient, disciplined, approach to identifying, investing in, and exiting portfolio companies. This structure is ideal for illiquid assets requiring longer holding periods to realize full value, allowing managers to pursue long-term growth without redemption pressures. Their focus on value-add strategies and substantial capital appreciation has historically led to very attractive total returns. Furthermore, the inherent lock-up protects the fund from being forced to sell assets prematurely due to investor redemptions, enabling more strategic and potentially profitable timing of exits.
Disadvantages and Risks
Despite their advantages, evergreen funds come with challenges. One significant hurdle is the valuation of illiquid private market assets, requiring frequent (often monthly) NAV calculations, which can be subjective due to the lack of readily available market prices. While promising liquidity, this can be tested during market stress or poor performance, leading to a surge in redemption requests that might exceed the fund’s liquid assets. Managers may then use liquidity management tools like redemption gates or temporary suspensions, potentially frustrating investors. Market volatility can exacerbate this, forcing asset sales at unattractive prices. To manage redemptions, evergreens might hold a portion of their portfolio in more liquid, lower-yielding assets, creating a potential drag on returns. Continuous capital inflows can also pressure managers to invest even when opportunities aren’t optimal. Finally, the performance fee mechanism of some evergreen structures (which may charge these fees on unrealized gains), is less aligned.
Traditional closed-end funds also have distinct disadvantages. The primary drawback is their illiquidity and long lock-up periods, often exceeding 10 years, with limited or no early redemption options. This can be a major concern for investors needing earlier access to capital. Slow capital calls over a period of years can also serve as a point of frustration for investors, while the significant minimum capital commitment requirements often make them inaccessible to many individual investors. That said, here at Prime Quadrant, we have had much success working with managers to lower these minimums, thus opening up access for the majority of our clients. Investors in closed-end funds may also experience the J-curve effect, where returns can be low or even negative initially due to management fees being charged before investments mature. Investors typically have limited influence on investment decisions and might lack full transparency into specific holdings until later in the fund’s life (“blind pool” risk), relying heavily on the manager’s expertise.
Conclusion
Both evergreen and traditional closed-end funds offer valuable pathways into private markets, but they clearly cater to different investor needs and preferences, each with its own set of advantages and disadvantages. Evergreen funds offer greater liquidity and accessibility, broadening the investor base. However, this flexibility comes with increased complexities in valuing illiquid assets and potential risks related to redemptions, especially during volatile periods. Traditional closed-end funds, on the other hand, offer a more disciplined, long-term investment approach with a strong alignment between managers and investors. Yet, they require investors to accept significant illiquidity and navigate that initial period of potentially negative returns.
Since the inception of Prime Quadrant, we have been helping our families access private market opportunities offered in traditional closed-end fund vehicles. We have been able to offer our families institutional quality opportunities which frequently have high minimum investments by negotiating lower investment minimums for our clients. This has served to mitigate the highest barrier to entry typical for most investors. We have also carefully constructed client portfolios to manage the inherent illiquidity of these investments, believing that investors of a certain size should harvest the premium associated with this illiquidity. However, as the marketplace has evolved with an increasing number of evergreen vehicles, we have taken a thoughtful and careful approach to integrating these into family portfolios. We believe we are in the early part of a cycle and the growth in evergreen strategies is set to accelerate. Managers will waste no time moving toward potential new pools of capital. While we see new products coming to market which are compelling, we increasingly see others which are far less attractive. As this evergreen capital cycle plays out, we expect there will be significant bumps along the way. Our approach will be to continue recommending both structures to our families while remaining astute to the inherent risks of both. Ultimately, the optimal choice between these two fund structures depends on each family’s individual circumstances, including their investment horizon, liquidity requirements, and overall risk tolerance.
