Private Credit Evergreen Funds Surge, Raising New Risks for Industry

(Bloomberg) — Private credit is pulling out all the stops to attract retail investors with increasingly popular open-ended vehicles that are bringing a new set of risks for the fast-growing industry.

A record number of so-called evergreen funds, which are a better match for the liquidity requirements of individual investors, will be started in North America this year, a report by Goldman Sachs Group Inc. predicts. Open-ended structures already accounted for 18% of all private credit fund launches last year, according to data from Preqin Ltd.

Unlike their close-ended peers with predefined exit horizons, evergreens don’t have a fixed termination date. They also allow investors to cash out at periodic intervals and accept money on an ongoing basis. They’re likely to be at the forefront of the push to get private markets into 401(k)s.

In a victory for alternative asset firms, US President Donald Trump is set to sign an executive order on Thursday that would allow them to tap some of the roughly $12.5 trillion held in participant-directed retirement plans.

Ease of entry and exit means that asset managers from secondaries specialist Pantheon Ventures Ltd. to the Liechtenstein Royal Family’s alternative investment firm have launched their own evergreens. 

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The increasingly popular funding structure, part of private credit’s spectacular growth, raises question about the soundness of the model.

The industry has been mostly reliant on long-term investments, not potentially flighty shorter-term deposits, reducing systemic risk and the threat of bank-run scenarios. Open-ended funds are also forcing a rethink about issues such as liquidity and fee structures.

“There’s always a delicate balance between targeting higher returns and maintaining sufficient liquidity to honor redemption requests as they come,” said Khang Nguyen, chief credit officer at Heron Finance.

Reducing Risks

Long-term funding better matches the type of investments carried out by private credit firms. The investments are not easily traded and often held to maturity for five to seven years. Private credit has grown to a $1.7 trillion industry as global interest rates have risen, boosting returns on floating-rate loans.

The International Monetary Fund warned last year that “the recent shift toward semi-liquid evergreen structures could increase liquidity risks over time.” Credit analysts at Moody’s Corp. echoed that concern in June.

Firms are not blind to this. NorthWall Capital LLP has created a “hybrid” evergreen structure in its senior lending strategy, including an initial lock-up period and a notice to redeem on a quarterly basis. “As the underlying assets run off, they are repaid, so we don’t have any pressure to liquidate assets,” said Alexander Garnier, founding partner and portfolio manager at the London-based alternative credit firm.

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The practice of gating — or limiting withdrawals — can be useful to manage flows and reduce the risk of premature, forced asset sales, Heron’s Nguyen said. However, the more illiquid assets an evergreen holds, “the less likely investors are to exit fully, or at all, during market stress, especially within the desired time frame” as such moves would probably reduce returns, he added.

For private credit managers, fundraising cycles drain time and resources, while open-ended structures can in theory provide a steady flow of new funds. Meanwhile, investors won’t need to decide whether to reinvest in a manager’s new fund, but can simply leave their capital in one place. Furthermore, joining an existing fund can bring returns more quickly.

“The traditional fund structures typically haven’t served our single or multi-family office clients well and so we’ve spent more time looking at different ways to allocate, developing our own evergreen strategy,” Jason Proctor, managing director for Troviq Private Markets Group Ltd.

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These include investments through the secondary market for trading stakes in funds as well as separately managed accounts, vehicles that are tailored, often to single investors, he said.

Structuring Fees

The jury’s still out as to how market fees will be structured. Private credit giants KKR & Co Inc. as well as Carlyle Group Inc. have been in the market with funds that don’t have performance fees, known as carry, which is meant to incentivize investors.

There’s some confusion about how to set performance fees for fund managers without the end date of a traditional fund, risking a removal or reduction of performance bonuses that may lead to attrition for a fund’s best employees, investors worry.

Research from Bloomberg Intelligence suggests alternative asset managers’ deepened focus on retail channels — which includes evergreen vehicles — could add $10 billion to $20 billion of management fees.

Nayef Perry, managing director and head of direct credit at Hamilton Lane Advisors Inc., said his firm has been in the evergreen space for more than half a decade, enabling it to build the needed “plumbing” before the latest rush seen across the industry. 

“It’s still very early to say whether mistakes will be made in the market, but having the scale and infrastructure are important to successfully launching these structures,” Perry said. Nevertheless, there’s “a lot of room for growth” with evergreen funds still accounting for as little as 5% of the total net asset value of the industry, he added.

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