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Evergreen funds: Accessing
private markets alpha

April 22, 2024 | 6 min read

Private markets have historically and consistently outperformed public markets, with time-weighted returns over rolling 5-year periods showing private equity buyouts generating an average premia of 670 basis points over the MSCI ACWI Total Return.1 Yet, private markets investing has traditionally been reserved for institutional investors and ultra-high net worth individuals – investors who are able to meet the high investment minimums traditionally associated with private markets.

As regulation evolves and new product innovations are launched, the door to private markets is opening. Structural barriers such as longer-term capital lock up periods that limit liquidity and the complexities and time required to create a private markets portfolio are being removed. More investors can now tap into the potential outperformance and diversification benefits offered by private markets investing by making a single investment in an evergreen fund.

Read more about why private markets have the potential to provide outsized returns and how evergreen funds are changing the way investors can access this asset class.

Why private markets?

To understand how private markets can provide distinct benefits to an investor’s portfolio, it is important to consider the ways in which private markets differ from public markets.

A broader investable universe

When compared to public markets, private markets provide investors access to a larger and differentiated opportunity set comprised of a diverse set of companies at varying stages of development and growth. There are approximately 20 times more global private equity-backed companies than the companies included in the MSCI All-Country World Investable Market Index, the broadest public market index available.2 Globally, there are nearly 200,000 private equity-backed companies across buyout, growth equity, and venture investments,3 representing a wide range of companies from early-stage start-ups to more mature companies, along with a wide group of formerly publicly traded companies that have decided to return to private ownership.

Sizing the private markets opportunity set

Source: PitchBook data as of February 2, 2024, and MSCI data as of December 31, 2023. Private markets comprised of buyout, growth equity, and venture capital companies. Public market comprised of all constituents in the MSCI All-Country IMI Index.

The ability to invest in a broader investable universe comprised of many companies which are at earlier stages of growth, presents an opportunity for outsized returns. The exposure to small and mid-market companies offered by private markets is significant, with median private equity enterprise value projected at $243 million compared to the median public market capitalization of $2.3 billion.4

More active engagement

Compared to their public market counterparts, private fund managers typically follow a more active and engaged approach with the underlying portfolio companies they acquire. Often, they have a controlling interest in the portfolio company and, therefore, the ability to influence the value creation strategy. The lack of publicly available information across a much wider investable universe creates the possibility for significant information asymmetry, allowing diligent and prudent private market investors the potential to optimize returns by influencing both the day-to-day operations and longer-term value creation strategy of the portfolio company.

Value creation strategies

Because private fund managers are generally more engaged with their underlying portfolio companies, private markets investing typically seeks to create return premia and potentially optimize returns for investors in three distinct ways:

Earnings growth

Value derived from operational improvements such as developing new products, synergistic M&A, and global expansion

Multiple expansion

Buying smaller and/or public companies going through a tough time at a lower valuation and selling them at a higher multiple

Debt reduction

Optimizing the capital structure by adding and removing leverage effectively

Risk/return benefits

While the broader macroeconomic environment influences private assets in a similar manner to public markets, as shown in the chart below, private equity (both buyout and venture) has historically generated meaningfully higher time-weighted returns and exhibited lower downside risk across all three time periods compared to public markets (MSCI ACWI). This dynamic is driven by a combination of active ownership which can provide support to portfolio companies in challenging markets, a preference for resilient businesses, and less reactive private markets valuations. Combining the potential for higher returns and lower downside risk, private equity can generate better risk-adjusted returns and provide diversification to an investor’s portfolio.

Private markets performance remains strong relative to public markets

Time-weighted returns

Higher returns

Downside risk

Lower downside

Risk-adjusted returns

(Sortino ratio)

Better
risk-adjusted returns

Source: MSCI and S&P Capital IQ data as of June 30, 2023. All returns in USD. Downside risk represents maximum peak-to-trough drawdown over the stated period. Past performance is not a reliable indicator of future performance.

Accessing private markets via evergreen funds

Evergreen funds provide investors with a number of benefits when investing in private markets, as outlined below.

Immediate diversification

A private markets investment program should be diversified across several dimensions including sector, geography, vintage year, and strategy. Evergreen funds often invest in more than one private markets strategy (secondary investments, direct co-investments, primary investments, etc.) and can provide diversification across a range of geographies and vintages, offering investors access to an established private markets portfolio with a single subscription. Investing in an evergreen fund can remove the operational complexities associated with building a well-diversified and resilient private markets portfolio “from scratch.”

J-curve mitigation

Private markets investors often experience what is commonly referred to as the “J-curve” effect, or negative returns early in a traditional private fund’s life that become positive over time – giving the appearance of the letter J on a performance graph. Practically speaking, after an initial investment is made, portfolio performance is negative as capital is injected into the business without initial gain in value. Over time, and as investors continue to fund the commitment, gains begin to accumulate on the paid-in amount and investors can begin to harvest the gains by selling and realizing interests once the total value of the investment is greater than the initial commitment. Investing in an established evergreen fund can mitigate the impact of the negative side of the J-curve and remove the cash drag of a typical 10-14-year closed-end private equity drawdown structure where early negative returns can weigh on performance early in the life of a private markets commitment.

Manager access

There is a wide dispersion of returns across the private markets manager universe, and access to many of the top quartile managers can be challenging. Oftentimes, top GPs, particularly within venture capital, are oversubscribed and only grant allocations to investors with whom they have long-standing relationships. Furthermore, there can be significant upfront capital requirements to access top private equity managers during pre-set fundraising periods. Through a multi-manager or open-architecture approach, evergreen funds can provide investors access to multiple GPs in one investment. This can significantly reduce the time and research spent in having to find the best managers in each sub-investment class.

Snapshot comparison:
Traditional private equity versus evergreen funds

With the evergreen market evolving quickly, there are many different options for new and existing investors to consider. Whether a single-manager or multi-manager product, and no matter the desired investment objective, we believe proper execution of an evergreen strategy can accelerate outcomes for investors of all types. Thus, understanding evergreen fund product specifications and provider capabilities are crucial considerations for potential investors.

For illustrative purposes only and not a complete list of differences.

Evergreen funds are pioneering a new way to access private market returns. These funds seek to offer investors instant exposure to a diversified private markets portfolio in a single subscription with lower investment minimums, potential for enhanced liquidity, greater flexibility to meet investment objectives, and less operational complexity compared to traditional private markets investing.

For individual investors, evergreen funds could well serve as a valuable complement to a public equity portfolio, an enhancement to an existing closed-end private markets portfolio, or as an access point for investors new to private markets who wish to enhance risk-adjusted returns while preserving an option for liquidity if their personal circumstances change. Evergreen funds could also be used as a satellite liquidity solution for experienced institutional investors with a mature portfolio of closed-end traditional private equity funds seeking to adjust exposure back to a targeted strategic asset allocation level. Either way, evergreen funds are opening the door to private markets investing, offering both new and existing investors access to potential outperformance and diversification benefits.

Would you like to discuss evergreen solutions and how they can play a role in your portfolio?

Contact us
Footnotes
  1. MSCI data as of June 30, 2023. Calculated as the average spread of rolling 5-year time-weighted global buyout funds return over rolling 5-year MSCI ACWI total return. 12/31/2001-6/30/2023. Past performance is not a reliable indicator of future results.
  2. Pitchbook, data as of February 2, 2024, and MSCI, data as of December 31, 2023. Private markets comprised of buyout, growth equity, and venture capital companies. Public market comprised of all constituents in the MSCI All-Country IMI Index.
  3. Pitchbook, data as of February 2, 2024.
  4. PitchBook and MSCI data as of September 30, 2023. PE backed companies include buyout, growth, and venture. Median PE enterprise value is defined as the sum of the absolute differences between private/public sector exposures for PE-backed deals invested for the period 2018-2022.
Disclosure

HarbourVest Partners, LLC is a registered investment adviser under the Investment Advisers Act of 1940. This material is solely for informational purposes and should not be viewed as a current or past recommendation or an offer to sell or the solicitation to buy securities or adopt any investment strategy.  The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication, are not definitive investment advice, and should not be relied upon as such. This material has been developed internally and/or obtained from sources believed to be reliable; however, HarbourVest does not guarantee the accuracy, adequacy, or completeness of such information. There is no assurance that any events or projections will occur, and outcomes may be significantly different than the opinions shown here.  This information, including any projections concerning financial market performance, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. The information contained herein must be kept strictly confidential and may not be reproduced or redistributed in any format without the express written approval of HarbourVest. 

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Professional Investor Definition

“Professional Investor” under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) (the “SFO”) and its subsidiary legislation) means:

(a) any recognised exchange company, recognised clearing house, recognised exchange controller or recognised investor compensation company, or any person authorised to provide automated trading services under section 95(2) of the SFO;

(b) any intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong;

(c) any authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong;

(d) any insurer authorized under the Insurance Ordinance (Cap. 41 of the Laws of Hong Kong), or any other person carrying on insurance business and regulated under the law of any place outside Hong Kong;

(e) any scheme which-

(i) is a collective investment scheme authorised under section 104 of the SFO; or

(ii) is similarly constituted under the law of any place outside Hong Kong and, if it is regulated under the law of such place, is permitted to be operated under the law of such place,

or any person by whom any such scheme is operated;

(f) any registered scheme as defined in section 2(1) of the Mandatory Provident Fund Schemes Ordinance (Cap. 485 of the Laws of Hong Kong), or its constituent fund as defined in section 2 of the Mandatory Provident Fund Schemes (General) Regulation (Cap. 485A of the Laws of Hong Kong), or any person who, in relation to any such registered scheme, is an approved trustee or service provider as defined in section 2(1) of that Ordinance or who is an investment manager of any such registered scheme or constituent fund;

(g) any scheme which-

(i) is a registered scheme as defined in section 2(1) of the Occupational Retirement Schemes Ordinance (Cap. 426 of the Laws of Hong Kong); or

(ii) is an offshore scheme as defined in section 2(1) of that Ordinance and, if it is regulated under the law of the place in which it is domiciled, is permitted to be operated under the law of such place,

or any person who, in relation to any such scheme, is an administrator as defined in section 2(1) of that Ordinance;

(h) any government (other than a municipal government authority), any institution which performs the functions of a central bank, or any multilateral agency;

(i) except for the purposes of Schedule 5 to the SFO, any corporation which is-

(i) a wholly owned subsidiary of-

(A) an intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong; or

(B) an authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong;

(ii) a holding company which holds all the issued share capital of-

(A) an intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong; or

(B) an authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong; or

(iii) any other wholly owned subsidiary of a holding company referred to in subparagraph (ii); or

(j) any person of a class which is prescribed by rules made under section 397 of the SFO for the purposes of this paragraph as within the meaning of this definition for the purposes of the provisions of the SFO, or to the extent that it is prescribed by rules so made as within the meaning of this definition for the purposes of any provision of the SFO.

The first of such classes of additional “professional investor”, under the Securities and Futures (Professional Investor) Rules (Cap. 571D of the Laws of Hong Kong), are:

(k) any trust corporation (registered under Part VIII of the Trustee Ordinance (Cap. 29 of the Laws of Hong Kong) or the equivalent overseas) having been entrusted under the trust or trusts of which it acts as a trustee with total assets of not less than HK$40 million or its equivalent in any foreign currency at the relevant date (see below) or-

(i) as stated in the most recent audited financial statement prepared-

(A) in respect of the trust corporation; and

(B) within 16 months before the relevant date;

(ii) as ascertained by referring to one or more audited financial statements, each being the most recent audited financial statement, prepared-

(A) in respect of the trust or any of the trust; and

(B) within 16 months before the relevant date; or

(iii) as ascertained by referring to one or more custodian (see below) statements issued to the trust corporation-

(A) in respect of the trust or any of the trusts; and

(B) within 12 months before the relevant date;

(l) any individual, either alone or with any of his associates (the spouse or any child) on a joint account, having a portfolio (see below) of not less than HK$8 million or its equivalent in any foreign currency at the relevant date or-

(i) as stated in a certificate issued by an auditor or a certified public accountant of the individual within 12 months before the relevant date; or

(ii)  as ascertained by referring to one or more custodian statements issued to the individual (either alone or with the associate) within 12 months before the relevant date;

(m) any corporation or partnership having-

(i) a portfolio of not less than HK$8 million or its equivalent in any foreign currency; or

(ii) total assets of not less than HK$40 million or its equivalent in any foreign currency, at the relevant date, or as ascertained by referring to-

(iii) the most recent audited financial statement prepared-

(A) in respect of the corporation or partnership (as the case may be); and

(B) within 16 months before the relevant date; or

(iv) one or more custodian statements issued to the corporation or partnership (as the case may be) within 12 months before the relevant date; and

(n) any corporation the sole business of which is to hold investments and which at the relevant date is wholly owned by any one or more of the following persons-

(i) a trust corporation that falls within the description in paragraph (k);

(ii) an individual who, either alone or with any of his or her associates on a joint account, falls within the description in paragraph (k);

(iii) a corporation that falls within the description in paragraph (m);

(iv) a partnership that falls within the description in paragraph (m).

For the purposes of paragraphs (k) to (n) above:

  • “relevant date” means the date on which the advertisement, invitation or document (made in respect of securities or structured products or interests in any collective investment scheme, which is intended to be disposed of only to professional investors), is issued, or possessed for the purposes of issue;
  • “custodian” means (i) a corporation whose principal business is to act as a securities custodian, or (ii) an authorised financial institution under the Banking Ordinance (Cap. 155 of the Laws of Hong Kong); an overseas bank; a corporation licensed under the SFO; or an overseas financial intermediary, whose business includes acting as a custodian; and
  • “portfolio” means a portfolio comprising any of the following (i) securities; (ii) certificates of deposit issued by an authorised financial institution under the Banking Ordinance (Cap, 155 of the Laws of Hong Kong) or an overseas bank; and (iii) except for trust corporations, cash held by a custodian.

Institutional Investor / Accredited Investor Definition

An institutional investor as defined in Section 4A of the SFA and Securities and Futures (Classes of Investors) Regulations 2018 is:

(a) the Singapore Government;

(b) a statutory board as may be prescribed by regulations made under section 341 of the SFA, as prescribed in the Second Schedule of the Securities and Futures (Classes of Investors) Regulations 2018;

(c) an entity that is wholly and beneficially owned, whether directly or indirectly, by a central government of a country and whose principal activity is —

(i) to manage its own funds;

(ii) to manage the funds of the central government of that country (which may include the reserves of that central government and any pension or provident fund of that country); or

(iii) to manage the funds (which may include the reserves of that central government and any pension or provident fund of that country) of another entity that is wholly and beneficially owned, whether directly or indirectly, by the central government of that country;

(d) any entity —

(i) that is wholly and beneficially owned, whether directly or indirectly, by the central government of a country; and

(ii) whose funds are managed by an entity mentioned in sub‑paragraph (c);

(e) a bank that is licensed under the Banking Act 1970;

(f) a merchant bank that is licensed under the Banking Act 1970;

(g) a finance company that is licensed under the Finance Companies Act 1967;

(h) a company or co‑operative society that is licensed under the Insurance Act 1966 to carry on insurance business in Singapore;

(i) a company licensed under the Trust Companies Act 2005;

(j) a holder of a capital markets services licence;

(k) an approved exchange;

(l) a recognised market operator;

(m) an approved clearing house;

(n) a recognised clearing house;

(o) a licensed trade repository;

(p) a licensed foreign trade repository;

(q) an approved holding company;

(r) a Depository as defined in section 81SF of the SFA;

(s) a pension fund, or collective investment scheme, whether constituted in Singapore or elsewhere;

(t) a person (other than an individual) who carries on the business of dealing in bonds with accredited investors or expert investors;

(u) a designated market‑maker as defined in paragraph 1 of the Second Schedule to the Securities and Futures (Licensing and Conduct of Business) Regulations;

(v) a headquarters company or Finance and Treasury Centre which carries on a class of business involving fund management, where such business has been approved as a qualifying service in relation to that headquarters company or Finance and Treasury Centre under section 43D(2)(a) or 43E(2)(a) of the Income Tax Act 1947;

(w) a person who undertakes fund management activity (whether in Singapore or elsewhere) on behalf of not more than 30 qualified investors;

(x) a Service Company (as defined in regulation 2 of the Insurance (Lloyd’s Asia Scheme) Regulations) which carries on business as an agent of a member of Lloyd’s;

(y) a corporation the entire share capital of which is owned by an institutional investor or by persons all of whom are institutional investors;

(z) a partnership (other than a limited liability partnership within the meaning of the Limited Liability Partnerships Act 2005) in which each partner is an institutional investor.

An accredited investor as defined in Section 4A of the SFA and Securities and Futures (Classes of Investors) Regulations 2018 is:

(i)  an individual —

(A) whose net personal assets exceed in value $2 million (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount;

(B) whose financial assets (net of any related liabilities) exceed in value $1 million (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount, where “financial asset” means —

(BA) a deposit as defined in section 4B of the Banking Act 1970;

(BB) an investment product as defined in section 2(1) of the Financial Advisers Act 2001; or

(BC) any other asset as may be prescribed by regulations made under section 341; or

(C) whose income in the preceding 12 months is not less than $300,000 (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount;

(ii)  a corporation with net assets exceeding $10 million in value (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe, in place of the first amount, as determined by —

(A) the most recent audited balance sheet of the corporation; or

(B) where the corporation is not required to prepare audited accounts regularly, a balance sheet of the corporation certified by the corporation as giving a true and fair view of the state of affairs of the corporation as of the date of the balance sheet, which date must be within the preceding 12 months;

(iii) A trustee of a trust which all the beneficiaries are accredited investors; or

(iv) A trustee of a trust which the subject matter exceeds S$10 million; or

(v) An entity (other than a corporation) with net assets exceeding S$10 million (or its equivalent in a foreign currency) in value. “Entity” includes an unincorporated association, a partnership and the government of any state, but does not include a trust; or

(vi) A partnership (other than a limited liability partnership) in which every partner is an accredited investor; or

(vii) A corporation which the entire share capital is owned by one or more persons, all of whom are accredited investors.

Continuation solutions encompass a host of transaction types in which a GP secures interim liquidity and/or additional primary capital for their LPs in a strongly performing asset, or set of assets, that the GP will continue to own and control. Specifically, they include continuation funds, new funds created by GPs for the purpose of acquiring the asset(s) that continue to be managed by the same GP and capitalized by one or several secondary buyers, or equity recapitalizations involving a direct equity or structured equity investment into a portfolio company. These transactions can also include a parallel investment from the GP’s latest fund into that same pool of assets (a “cross-fund trade”).