Buy Now Pay Later: Some Evergreen Funds May Not Be in Your Best Interest
We often talk about the potential misalignment of interests between investors and managers of evergreen (open-ended) funds in our Weekly Market Updates (if you haven’t subscribed, click here!). A quick summary of two of the more prevalent concerns seems apt for our Blog readers.
What is an Evergreen / Interval Fund?
Evergreen funds, a.k.a., open-ended funds, are investments that have no fixed end date or term (in contrast to closed-end funds). These offerings are also usually structured as interval funds. An interval fund will provide periodic liquidity for its investors, subject to restrictions, allowing them to sell shares during regular repurchase windows which are often quarterly and sometimes monthly. These funds have lower investment minimums than their closed-end counterparts, making it easier for many investors to access the private market / alternative investments.
Infinite Time Horizons vs. Short-Term Liquidity
Unfortunately, some managers and investors view the evergreen structure with different expected time horizons. Managers tend to view the structure as if they have perpetual capital (a never-ending faucet) to deploy, while many investors view them as the ability to withdraw their capital whenever they want. Evergreen funds are able to diversify many of the risks associated with closed-end funds. The two most common being vintage-year diversification and immediate exposure to the underlying asset class. However, these types of funds are also being sold to investors as a more liquid alternative investment. These open-ended structures allow individuals to sell earlier than the typical closed-end investment term, which is usually 10+ years.
So, there seems to be a misalignment here. Managers running funds assuming they will have the capital for decades, while many retail investors, and probably some institutional ones too, are being drawn in by the ability to get out whenever they want.
We've already seen what happens when investors, who seem to always want to sell at the same time, come into conflict with an evergreen fund that owns assets meant to be held long term (just search BREIT and SREIT).
Fees, Fees, Fees
An even more egregious misalignment: excessive fees, including management fees that could double when billed based on gross asset value instead of net asset value, or NAV (see WSJ article here). One of the challenging aspects of due diligence is to get an accurate, side-by-side comparison of the total expenses that are borne by investors for competing funds. While the management fee may be written out in plain English, operating costs and other asset-level expenses are typically not expressed as a percentage of AUM. Further, since interval funds often charge a 10-20% performance fee (a.k.a., carried interest) on NAV appreciation, subject to a performance hurdle which, in some cases, is insultingly low, the annual fee may even surpass 4%! Even without a performance fee or fund-level leverage (note, some funds may say there's no leverage, but the individual assets they own certainly are levered), annual all-in expenses are typically higher than 2%, often >3%. Does that mean evergreen funds are more expensive than closed-end funds? Not necessarily. But the devil is always in the details, and if a fund markets a sub-2% annual fee, just know that may be a far cry from reality.
At the end of the day, proponents of alternative investment will argue that what matters is the net results. Regardless of high costs, if a fund manager can deliver strong performance, net of all the fees, then it may be worth considering. We certainly welcome all discussions and feedback on this topic!
Regardless, the first step in any investment decision making process should be ensuring you have the clearest, most transparent, view of what you’re buying…before you buy it. Evergreen funds can offer diversification benefits by providing access to to asset classes—that have the potential to increase overall portfolio returns and/or supplement current income— that may otherwise be unavailable to most investors. As with most investments, it is important to have a skilled partner to help you evaluate these opportunities before you buy. Retail investors are very much in the “Wild West” phase of exploring private market investing and, unfortunately, many deals are still sold not bought. Be careful of who's selling it to you...and why.
Best Regards,
Adam J. Packer, CFA®, CAIA®
Chief Investment Officer | SineCera Capital