Make way for the evergreen revolution

Demand for private debt is growing from the likes of mutual funds and retail investors, which need an alternative to closed-end funds.

In an apparent contradiction, fundraising for private debt appears to be in decline while there is no evidence of any weakening in limited partners’ appetite for the asset class. From a high of almost $218 billion in 2017, the amount raised globally by private debt funds fell to a little over $151 billion last year.

The $33 billion collected in the first quarter of this year does not suggest that 2017’s record is likely be under threat in 2019. And yet, survey after survey has shown that LPs are keen to proclaim their continuing faith. Perhaps part of the problem is a lack of product choice. One periodic topic of conversation that PDI has with GPs relates to the swelling ranks of investors attracted by some of the chief characteristics of private debt investing but repelled by the closed-end fund structure.

We recently spoke with a London-based senior executive at a GP that offers both closed and open-end structures. Although, in his view, the closed-end funds “make sense to most”, there is more and more demand from investors that struggle with such funds either for regulatory reasons (such as mutual funds, see here) or for operational reasons (such as retail investors and family offices).

Operational challenges include the need to conduct due diligence and commit to new documentation, together with time pressure to get funding in place and manage capital commitments, on a recurring cycle. Retail investors, which struggle with these demands, nonetheless love some of the key characteristics of private debt investment: floating rates, high cash coupons, strong yield and downside protection, for example.

Unsurprisingly, therefore, evergreen funds – based on a model of redemptions and reinvestment – are growing in popularity. Already numerous in the US, they are just starting to emerge in Europe. In theory, private debt is well suited to the structure, as investments are short in duration – typically two to three years – compared with other alternative asset classes such as infrastructure. One asset class professional described private debt to us as a “self-liquidating asset class on a short duration, with regular repayments that drive liquidity”.

It may be an exaggeration to suggest private debt and evergreen funds are therefore a perfect match – the same source highlighted that meeting redemption and reinvestment demands involves careful portfolio construction to ensure the underlying assets have the characteristics that meet this demand for churn. But evergreen funds can undoubtedly play their part in ensuring that dollars are able to flow more easily into the asset class.

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