Private equity (PE) is an investment strategy that appeals to high-net-worth individuals and institutional investors alike. However, not all PE funds are structured the same way. Two primary types of private equity funds—closed-end funds and the newer open-ended, evergreen funds—are gaining attention, especially among wealth advisors and private investors.
If you’re considering private equity for your portfolio, it’s essential to understand the nuances between these two types of funds. This blog post explores the key differences, helping you decide which is right for your investment needs.
1. Ease of Access
One of the key differences between evergreen funds and traditional closed-end funds is ease of access.
- Evergreen funds are typically easier to access. Many are available to accredited investors, and some can be accessed by qualified clients. The minimum investment thresholds are generally lower compared to traditional closed-end funds, and the subscription process is simpler, making them a more accessible option for many investors.
- Closed-end funds, on the other hand, often have higher minimums, and the paperwork required to invest can be more complicated. As a result, these funds can be more challenging for smaller investors to access.
2. Tax Treatment
When it comes to tax filings, evergreen funds tend to offer a simpler process.
- Most evergreen funds issue a 1099, which is easier for individual investors to file. Even if the fund issues a K-1, it’s typically limited to a single state, reducing the complexity involved in preparing your taxes.
- Traditional closed-end funds, however, typically issue a K-1. These forms often include multi-state filings and require more time and effort to navigate, especially if the fund has investments in multiple states.
3. Capital Calls
Capital calls are a critical part of managing a private equity investment, but they can be a significant inconvenience for some investors.
- In a traditional closed-end fund, capital is called over a period of 3–4 years. The timing of these calls is often unpredictable, which can create liquidity challenges. For individual investors, this unpredictability can be difficult to manage.
- Evergreen funds simplify this process by requiring a single upfront investment. Once you’ve committed your capital, there are no additional calls to worry about.
4. Liquidity
Liquidity is a common concern with private equity, but evergreen funds generally offer more flexibility.
- Most evergreen funds feature quarterly redemption windows, typically allowing investors to redeem 3–5% of the fund’s AUM, at the manager’s discretion. While this has worked well in certain funds like BREIT and SREIT, the long-term liquidity in a downturn or recession is still uncertain.
- In contrast, traditional drawdown funds typically lock up your investment for 10–15 years, with no redemption options available until the fund’s exit.
5. Valuation
Valuation is another area where the two fund types differ significantly.
- In a closed-end fund, valuations aren’t a huge concern because all investors enter at the same time, and the fund exits when the portfolio is sold or realized.
- Evergreen funds, however, require continuous valuation of assets. Since new investors enter and exit at different times, it’s essential to rely on the manager’s ability to value the portfolio correctly. If the valuation is inaccurate, you may overpay or underpay for your stake in the fund.
6. Performance
The performance of closed-end funds and evergreen funds also differs due to structural factors.
- Closed-end funds generally target a higher IRR (Internal Rate of Return)—often around 15%—due to their active management and the fact that they can optimize IRR through tools like credit lines to delay capital calls.
- Evergreen funds, on the other hand, often hold a portion of assets in cash or equivalents (sometimes 20%+) to meet redemption requests. This cash buffer can dampen returns, and as a result, these funds typically target a more conservative 12% IRR.
Additionally, the cash allocation in evergreen funds makes it difficult to determine exactly how much of the fund is deployed in investments, which could affect overall performance.
7. Fees
Fees are a critical consideration when evaluating any private equity investment.
- Since evergreen funds are often marketed to the retail/wealth management channel, their fees are generally higher than traditional funds. Distribution costs add to this, and fees can vary significantly across different evergreen funds.
- In contrast, traditional funds typically calculate management fees based on committed capital, which remains static over time. This structure is more predictable and tends to result in lower overall fees over the life of the fund.
8. Entry & Exit Timing
How you enter and exit the fund can significantly impact your returns.
- With a closed-end fund, it’s often better to wait until the fund is closer to its close date to invest. This way, the portfolio is more “mature,” and potential unrealized gains may reduce the upfront cost. However, since these funds have a long time horizon (usually 15 years), any gains will likely be smaller.
- In evergreen funds, the optimal strategy is typically to invest immediately, as the fund’s composition can change rapidly due to inflows and redemptions. Secondary funds, however, offer better entry points early on, as the asset pricing is adjusted to market value.
9. Co-Investments
Co-investments can provide valuable exposure to specific deals, but they come with different implications in each fund type.
- Traditional funds often offer co-investment opportunities with low or no fees, making them attractive for investors who want to increase their exposure to a specific asset.
- In evergreen funds, direct co-investment opportunities are less common. If they do exist, you’ll still be subject to the same management fees as the rest of the fund, making the overall cost relatively higher.
Conclusion: Which Fund Type is Right for You?
For most private wealth investors, evergreen funds tend to be a better fit due to their easier access, limited liquidity, and simplified tax treatment. These funds are ideal for those who value flexibility and a more predictable investment experience. However, as the space evolves, it’s important to stay informed and conduct thorough due diligence. The right choice depends on your specific financial goals, risk tolerance, and investment horizon.
Feel free to reach out for further questions or assistance in evaluating your private equity options.