LPs are demanding greater flexibility and longer terms for private debt funds, as the maturing of the asset class drives demand for innovation.
Evergreen funds that offer all the benefits of private credit alongside enhanced liquidity options can appeal not only to existing large institutional investors, but also to newer investor bases coming to the asset class for the first time, fund managers say.
“We see a growing number of LPs saying they would like to have a liquid framework in private debt, which has always been treated as an illiquid asset class and structured out of closed-ended funds because you can’t easily get a daily price on it, particularly bilateral loans,” says Diala Minott, partner in the credit funds practice at law firm Paul Hastings.
“People want to be able to continue to reinvest interest and principal in a fund with a longer term, or even no term, and be able to redeem in and out – so they are really looking for more open-ended features.”
More and more managers are responding with bespoke vehicles that allow investors to either withdraw money after shorter investment periods or make their investments in perpetuity. The Carlyle Group and Blue Owl Capital’s direct lending arm, Owl Rock, are among the prominent names moving into the evergreen space, while Partners Group was also an early promoter of the approach with its €1.4 billion Private Loans Sicav Fund, launched in 2016.
Christopher Bone, head of private debt in Europe at Partners Group, says that Partners Group first saw demand for a debt-specific evergreen structures six years ago.
The fund, he says, appeals to institutional investors who like the option to increase their allocations over time, or reduce if they need to, without having to select new funds or deal with capital calls or subscriptions: “If they invest €10 million today, for example, it is immediately deployed and they can maintain that exposure over time without the need to due diligence new funds.”
The specifics of these evergreen funds vary, but LPs are increasingly homing in on the terms of the liquidity offered to investors, the rules around appropriate outflows and the basis upon which performance fees and carried interest can be calculated.
In 2018, Northleaf launched one of the first mid-market focused private credit evergreen programmes, investing 100 percent in private loans and structured with a lock-up period and liquidity provisions that enable investors to redeem their exposure.
David Ross, head of Northleaf’s private credit programme, says: “Our evergreen fund programme is now close to four years in, and our experience has been strong demand and growth for the evergreen product from a broad range of institutional investors. The demand for the evergreen product has outpaced our expectations, and the broader market acceptance has extended beyond North America to Europe, Asia and Australia.”
Ross says investors particularly like the ability to outsource the cash management element associated with traditional closed-end funds. Evergreen funds reduce that administrative element by continuously reinvesting capital on the investor’s behalf, enabling the investor to remain fully invested over time.
They also allow investors to move allocations easily between funds and exposures over time as their corporate strategies or risk appetites evolve. Evergreen products further appeal because they offer immediate exposure to well-diversified portfolios of loans, consistent quarterly cash yields, a more predictable cash call schedule and the ability to maintain exposure to strategies for longer.
Some evergreen funds offer a mix of exposures across private and public fixed income, to help deliver liquidity, but Ross argues that dilutes the private credit market risk premium. Instead, he says, evergreen fund managers need to provide strong origination skills and sophisticated risk management to create portfolios that can deliver stable returns and meet investor liquidity demands.
For investors, the upsides are compelling, creating a long-term trend benefiting both existing institutional private credit backers and newcomers to the asset class.
Bone says: “We think this is the way private credit is going to go as an asset class. In the US, we already see that direction of travel and open-ended programmes becoming a much bigger market, and we expect the same to happen here.”
Minott adds: “We are certainly seeing LPs wanting more liquidity right now, and that is partly because they are nervous about the economy and don’t want to be locked up for 10 years in a market where they don’t know what the value of their assets is going to look like. More and more they want the flexibility to be able to withdraw and re-allocate more easily, so this is a space to watch.
“As the private credit market matures we are seeing more innovation and the open-ended debt funds market is growing exponentially.”
Large asset managers with advanced operational platforms have long been comfortable with closed-ended structures for private funds, but they are wising up to the benefits of evergreen options. Meanwhile, the open-ended option further opens the doors for new investor types to come into private debt.
Reto Munz, head of private debt portfolio management at Partners Group, says: “In the current environment of rising rates, where traditional fixed income is not doing so well but private credit stands to benefit, new investors are coming into the asset class. We see many clients that have traditionally been in closed-ended structures switching to open-ended, and we see new types of investors looking to the asset class and seeking more liquid options.”
Ross says Northleaf always anticipated multi-channel and multi-region demand, starting with first-mover sophisticated institutional investors, then moving to consultants, market facilitators, and finally diversifying into the retail market.
“What is just starting now is a move to evergreen products outside North America,” he says, “where Australia and Asia are probably moving slightly quicker than Europe, where investors have been comfortable with closed ended funds for a long time. Those investors are coming from fixed income to private credit for the first time and evergreen feels like a natural evolution.”
However, it is the retail market that offers the largest potential, while also being the most difficult to penetrate. The education of that ecosystem is well underway, and those that can develop the evergreen structures capable of wooing those investors can look forward to handsome rewards.
The evergreen hurdles
While evergreen funds have some clear attractions to LPs, they do raise some issues for fund managers.
Reto Munz, head of private debt portfolio management at Partners Group, says the management of evergreen funds is more complex: “You take some of the trouble away from the investors and deal with that yourselves instead. You aim to be fully invested at all times and you have to manage your repayments and your investment pipeline as well as subscriptions and redemptions. You can’t call capital but you have the cash from repayments, and being able to provide the promised liquidity at all time is really crucial. Managing all that certainly adds an additional challenge.”