Evergreen Funds: Everlasting Appeal in Private Credit?

For both managers and investors, traditional closed-end funds¹ have historically been the structure of choice for illiquid, private assets. Evergreen funds, however, have become popular in recent times, and interest continues to grow, particularly in the context of private credit. These vehicles are seen in many guises: many do not have a defined life span and allow investors to redeem within pre-agreed parameters. What’s behind the continued interest in evergreen funds?

GP's perspective

Fundraising. In contrast to the traditional closed-ended vehicle where there is a time-limited window during which GPs can fundraise (for example, 18 months), an evergreen fund can accept new capital whenever it is needed. Whilst also putting less pressure on raising enough capital in a relatively short period of time, the fundraising process should be quicker and simpler because the manager does not need to establish a new vehicle and negotiate terms for a new fund each time it wants to fundraise. The manager simply offers an investment opportunity in the evergreen fund to the interested investors and uses the same vehicle for successive fundraising rounds.

Deployment. In addition, an evergreen fund can smooth the rate of deployment, relying on internal cash generation to pay for new investments as an evergreen fund’s portfolio is generally constantly recycling.

LP's perspective

Capital at work. Due to the life-cycle of the closed-ended structure (i.e., (1) Commitment ➔ (2) Drawdown/Deployment ➔ (3) Return of Capital) there can be a material difference in terms of an investor’s ‘allocation’ to a strategy in comparison to an investor’s ‘exposure’ to a strategy. To reduce this ‘inefficiency’, in the context of typical closed ended funds, GPs typically try to align the harvesting period of the then-current closed-ended fund with the fundraising period of the next successor fund so that investors re-commit to the successor fund (thus diminishing the impact of having capital out of the market). However, this may not always be possible to achieve.

In contrast, rather than committing capital to a fund and then holding the committed amount in cash, cash equivalents or other liquid assets until the capital is deployed, evergreen funds may draw cash more quickly for investment thus increasing an investor’s ‘exposure’ to a strategy for a relatively longer period. In addition, evergreen funds may not have a specified run-off period that begins at the end of the investment period and so cash generated from investments may be reinvested in new investments such that, once again, the investor’s capital is exposed to the strategy for a relatively longer period.

Due diligence. Due to the time-limited nature of a typical closed-ended fund, once investments are sold, the proceeds from the sale are typically returned and distributed to investors. The investors must then re-assume responsibility for allocating this capital by, for example, finding a new strategy, a new manager and/or a new fund (including deployment in a successor fund). It can take time to find and due diligence the ‘right’ manager, or indeed to wait for the manager who just returned the capital to raise its next fund.

In contrast, after investors carry out the initial due diligence, depending on the structure of the fund, evergreen funds may offer the investors the ability to maintain a stable and ongoing exposure to the asset class, strategy and manager as the capital is invested and re-invested in perpetuity (or at least may be held for longer than a typical closed-ended fund).

Impact of AIFMD 2.0

However the structure of certain open-ended style evergreen credit funds may be impacted by the introduction of AIFMD 2.0, which introduces a number of restrictions on open-ended funds in Europe. In particular a credit fund that meets the definition of “loan-originating AIF” under AIFMD 2.0 will need to be ‘closed-ended’ unless the AIFM can demonstrate to its home state regulator that the liquidity management procedures of the fund are compatible with the investment strategy - whilst further guidance is expected, the expectation is that truly evergreen funds (i.e. those that offer liquidity at the option of the investor) will in principle be considered ‘open-ended’ and subject to this restriction. See ‘Changes to the EU Loan Origination Landscape – How are Private Credit Funds Impacted’ for further information.