On this episode of The Long View, Hilary Wiek, principal analyst at PitchBook, a Morningstar company, discusses how investors can start to invest in private markets, the rise of evergreen funds, and why the markets are being opened to smaller investors.
Here are a few excerpts from Wiek’s conversation with Morningstar’s Christine Benz and Ben Johnson.
How Individual Investors Can Invest in Private Markets With Evergreen Funds
Ben Johnson: Hilary, you mentioned “evergreen vehicles.” There’s a variety of names floating out there in the marketplace today: semiliquid funds, perpetual capital vehicles. I personally am trying to trademark the term “semi-perpetu-green” to just put it all to rest, though that’s a mouthful. I’m curious if you could speak specifically about what types of vehicles are evergreen vehicles. What is driving growth in both manager and investor interest in this space, and kind of frame it in the broader evolution of different access points investors have at their disposal to private markets?
Hilary Wiek: I’ll just say upfront that our team put together a paper a little over a year ago called The Evergreen Evolution that talks a lot about this if people want more than what I’m about to say. But I talked earlier about the trend of institutional capital going away, that pensions aren’t being created, and a lot of them are freezing or derisking. And so, money managers are looking for new sources of growth for their assets under management. I would say another trend that, in my opinion, is causing this is that the largest money managers went public, and Wall Street appreciates consistent growth and consistent earnings. And they like that these evergreen funds are going to create that growth, and they have a nice steady income stream from fees rather than having to wait for the performance returns that they get from the 20% performance fees and a drawdown structure. So, the asset managers really like this.
And then on the other side, you’ve got the investment individuals who have been previously excluded from this because they didn’t have the capital to invest. A lot of times, minimums on private market funds can be $1 million or more. By creating these new structures, they have lower account minimums. They’re creating structures that have a little more liquidity. You talked about the structures we’re talking about. I would say the largest at the moment are interval funds in terms of getting exposures in a semiliquid product. The interval being discussed there is how often you can get out of the funds. I talked earlier about how, in drawdown funds, you can only get out by maybe using the secondary market. With the evergreen funds, the fund manager provides liquidity. The common structure for an interval fund is quarterly. They will allow up to 5% of the assets of the fund to be liquidated or to be redeemed, I should say.
There are other structures. There are tender-offer funds. There, I believe, instead of promising 5%, it’s more of a when the asset manager feels like they have some liquidity to offer, they will offer it. So, it’s a little more in the hands of the asset manager. There are also BDCs, which are business-development companies, which are credit working with smaller companies. And the fourth type that we’re tracking is nontraded REITs, so real estate investments. I’m probably most familiar with the first two structures at the moment, as we put out some research that kind of defines each of these types.
But our umbrella term at PitchBook has been “evergreen.” I think Morningstar has been leaning more toward “semiliquid,” but we are talking about the same things here. And I think there were more parts to your question that I might have missed, so apologies.
Johnson: You absolutely, I think, hit on some key components there, just with respect to the historical framing and also just specifically what some of these new and different access points are that exist under this umbrella.
How Financial Advisors Can Integrate Private Markets Into Client Portfolios
Christine Benz: Following up on that, Hilary, I wanted to ask about the push to get smaller investors into private markets. If I’m a financial advisor thinking about whether and how to integrate private markets into traditional allocations, traditional client portfolios, how should I approach it?
Wiek: The piece I have coming out next week is actually going to be really helpful, I think, to a lot of people. It is providing a lot of questions for fund managers on how to diligence what’s going on, because there are right now, there’s a lot of dispersion among the evergreen funds that are being created. And when you say how to approach it, I would say that unless your client can put to work, I don’t know, $2 million to $10 million a year into private markets, they probably are thinking about this evergreen fund structure rather than direct fund commitments into drawdown funds. It is a diversifier. It is a way to hopefully get access to an illiquidity premium out there by being patient with your capital.
I will say that for investor suitability, patience should be a characteristic of that investor. If they are getting into these products because there is some liquidity and they hope to be able to trade in and out of it, that’s probably not a great fit. A lot of the fund managers actually are kind of bristling at the term “semiliquid” because they don’t want to put too bright a light on the liquid part. There will be moments in time where liquidity in the market is not advantageous to a fund, and they don’t want investors flooding out of the funds because they get scared about the markets. They want people with an attitude of long-term thinking, who are willing to park some money for the long term into assets that have a long-term perspective. When you’re buying an entire company, you should be thinking longer term than if you’re buying a few shares that you can flip out at a moment’s notice. So, I would say personality or the investor’s profile is important for how you’re thinking about this.
Now, there are all sorts of asset-allocation considerations to think of. I think there are a lot of people talking about maybe taking half from your equity. If you were to do maybe a 20% allocation to privates, maybe half from your equity, half from your fixed income, I will say that a lot of the products that have been created thus far, well, I think there’s a lot of hype out there—and I wrote a different paper last quarter—about, “Oh, adding private equity to your portfolio is going to add a lot of return to your portfolio.” And while that may or may not be true, most of the products that have been created have been income-producing. They’ve been credit funds, real estate funds, and infrastructure funds. And part of that is because of the liquidity profile. If you’re talking, that you’re promising 5% liquidity a quarter, it’s nice for the asset manager to be spinning off income that they can use to pay for redemptions that come through. If you buy a whole company, you can’t sell part of that company to fund a redemption request. And so, people should be thinking about what product offerings are out there. They should be looking at track records. They should be looking at the underlying aspects of the fund management.
As I said, the paper I just finished is just filled with questions that folks should have. One of the examples I use is maybe you buy this evergreen fund because it’s got a great name brand, because you’re not as familiar with private markets. But you need to look under the hood and make sure that name brand actually is backed up by a team that really understands this shift in liquidity profile. Drawdown fund managers haven’t had to think about funding redemptions ever. They’ve never had to figure out, oh, if somebody gives me their entire fund’s investment upfront, then they’ve got to find a place to park that. And in drawdown funds, teams have only ever called capital when they have a good idea, and then they’ve given the capital back when they sold that idea. So, it’s a different way of thinking through things, and they need to make sure that the folks entering this market have really thought through some of the questions that make management of these portfolios very different from what they’ve done in the past.
Ask Your Advisor These Questions Before Investing in Semiliquid Funds
Are Private Markets Worth The Complexity?
Benz: I could see someone listening, whether a financial advisor or certainly an individual investor, and they might conclude, this is all in my “too-hard pile,” that it might not be worth the incremental return advantage I might obtain by investing in some of these asset classes. Is that a legitimate point of view, do you think, that some people might just want to walk on by?
Wiek: Oh, absolutely, it’s legitimate. I mean, nobody should get into things they don’t understand. If you’re not able or willing to put in the time to understand it, then I think there are perfectly good options in the public space.
I will also say that “just because you can doesn’t mean you should.” There are time horizon issues that if you are saving up money to buy your yacht next year, probably shouldn’t park it in something that is, even though semiliquid, it is considered a long-term investment. So, as always, you should be thinking about suitability in terms of your investment time frames with these.
And the other, “just because you can doesn’t mean you should” consideration is look very hard at the fees on these things. The less you put in, the higher your fees probably are going to be. And there are layers upon layers of fees that are being charged on these. There can be fees for getting into the fund and fees for getting out of the fund. There can be lockup periods. There can be expense ratios. There can be performance fees. Morningstar is doing a great job of vetting these funds and putting ratings on them, and I would encourage people to take a look at that because they are being very thoughtful about all of this. And I think PitchBook and Morningstar are hopeful that the work that we’re putting in may cause the industry to converge and be a little bit less complex. Because right now, it’s been really hard to add up what all the fees are and whether it might actually be worthwhile.
