Private Markets Talks: Investment trusts vs open-ended evergreen funds
James Lowe interviews Solomon Nevins, founder of The Fund Review, on the relative merits of accessing private assets via listed investment trusts and open-ended evergreen funds, including sharing the findings of research into fund returns.
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Key Takeaways:
Access: Both investment trusts and open-ended evergreen private asset funds can provide easier access to private markets compared to traditional drawdown funds, with smaller initial investment sizes and a single investment into an already ramped-up portfolio. Both evergreen and investment trusts can be complementary access points to private markets for UK wealth investors.
Liquidity and structure: Investment trusts offer daily liquidity via stock market trading, enabling flexible position adjustments, but also come with equity market beta, while open-ended evergreen funds provide NAV-linked valuations, but with less frequent subscription and redemption opportunities.
Performance differences: Over long-term periods, traditional private markets funds have generally outperformed the investment trust market, likely due to their focus on total returns and capital growth. Investment trusts are often more income-orientated, which may align well with some investors’ portfolio goals.
Volatility and diversification: Private markets have historically also offered lower volatility, and some asset classes can provide low correlation to public markets, providing resilience and diversification during market stress. Investment trusts can be more correlated to broader equity markets than private fund and open-ended funds due to being listed stocks themselves.
Q&A transcript:
James Lowe: Hello everyone, and welcome to Private Markets Talks. In today's episode, we're going to be talking about the open-ended evergreen private market fund, and how that compares to the better-known investment trust landscape. To discuss this, I am very pleased to be joined in the studio today by Solomon Nevins. He's the founder of The Fund Review, a private markets research company, and also has previously run private client money in a multi-asset context, focusing on private markets and alternatives.
What are the different types of private markets access points available for UK wealth management firms?
Solomon Nevins: To access private assets, and when we talk about private assets, we're thinking infrastructure, real estate, private credit, private equity, there is a range of different fund structures that investors can get exposure through. One of the most popular for the wealth manager community in the UK, certainly, has been the investment trust vehicle, also known as listed closed-end funds, or investment companies. These are funds that issue a fixed number of shares through an IPO or capital raise, and the capital that shareholders provide is used to buy assets in line with the investment strategy.
These shares then trade on the stock market, which allows investors to get regular liquidity through trading those shares during market hours. As a structure, it's well suited to owning private assets in that the closed-end structure means the manager is never required to meet redemptions. Investors get the liquidity through trading.
The other structure that's on the rise and becoming increasingly popular or of interest to the wealth management community is the open-ended evergreen private asset fund, also known as evergreen funds or open-ended private asset funds.
This is a different structure whereby rather than there being a fixed number of shares, the fund can grow or shrink in line with investors' subscriptions or redemptions, like a traditional mutual fund. In the same way, the manager will use those investor flows to buy assets, and investors seeking to make subscriptions or redemptions will do so at certain periods through the calendar, typically monthly for subscriptions and quarterly for redemptions.
Both structures have made access to private assets easier than it has been historically where the traditional fund vehicle was the drawdown fund, which is a 10-12-year life fund where investors lock up their capital for that period of time and are typically required to make large initial investment commitments.
James Lowe: What are the pros and cons of listed closed-ended funds versus open-ended evergreen funds?
Solomon Nevins: The open-ended evergreen funds and the investment trusts share a couple of common characteristics relative to traditional vehicles in that when investors make their initial commitments, they are typically going into a fund that's already fully invested, where they've got very good visibility through the underlying portfolio investment, which means the portfolio should be return-generating much more quickly than in a traditional fund.
There isn't that blind pool risk, this uncertainty about what the fund manager will go and buy once you make that investment. They also have an element of flexibility around trading. You can come in and out - and the initial investment size that you need to make is much smaller than traditional funds.
But there are differences as well, with liquidity being one of the most prominent.
We mentioned that on the investment trust side, the shares are traded on the stockmarket. That means there is continual liquidity through trading hours, which is useful for being able to flexibly adjust position sizes. But with that comes volatility.
Essentially, the investor's exposure, their performance, is linked to the share price rather than the net asset value, which is the valuation of the underlying assets.
What that means is that in periods of marketing stress, the share price and the NAV can become disconnected, and therefore, the performance that the investors' experience can be driven by equity market forces or other factors, and not necessarily the performance of the underlying investments. There are advantages or attractive features of this, such as when there has been that disconnect, it makes it possible for investors to access these assets at a discount to intrinsic value, or discount to the NAV.
Taking the open-ended evergreen funds, what the shareholder or the investor gets in this situation is exposure to the NAV. Historically, those have been much more stable and connected to the performance of the underlying assets than the share price experience you get on the investment trust side. They still come with the flexibility to make subscriptions or redemptions and adjust position sizes, albeit without the frequency that you get in the investment trust market.
One of the key risks and concerns that a lot of investors have is around the liquidity mismatch between the underlying private assets and the dealing terms that are presented to the investors in those funds. To manage that liquidity mismatch, the fund managers of the private asset funds, the open-ended evergreen funds, need to maintain an allocation to liquid assets, which may be a drag on returns over time.
There's the liquidity that you get with an investment trust, which is not matched by a open-ended evergreen fund, but the other side of this is the potential diversification angle of having NAV pricing. Therefore, there are different reasons for being in a client portfolio or investing in that product.
James Lowe: You've done some research looking at the performance profiles of the listed market versus the open-ended evergreen market and also the private funds market. Could you talk us through some of the findings?
Solomon Nevins: We did a study looking at the performance of open-ended evergreen funds, listed closed-end funds, and traditional closed-end funds over 10 and 15-year time periods. The open-ended evergreen funds are a relatively young sector, but many of the conclusions or views about that you can infer from the traditional closed-end fund space.
What we found is that the performance of private funds has outperformed the investment trust market over the long term. That may be due to several reasons.
Firstly, the investment trust market is dominated by income-heavy strategies, whereas on the private fund side, the open-ended evergreen side and the traditional private asset side, there's much more focus on total returns and capital growth, so higher-return objective strategy. There may be a quality bias to the managers operating in the private fund space.
The performance is slightly better on the private fund side. The biggest impact, though, for overall risk-adjusted returns that investors can experience, comes from the return profile of the two different types of investments. Taking diversification, or correlation to start with, across the listed closed-end fund space over the last 15 years, correlations with global equities have been at least 0.8.
On the private fund side, whilst private equity and private credit have similarly high levels of correlation with global equities, infrastructure and real estate had very low, or slightly negative, correlations over that period.
Importantly, whilst on the private fund side, private equity and private credit have been directionally very similar to global equities, the volatility is much lower. We found that accessing private equity through listed closed-end funds had two and a half times the level of volatility versus investing via private asset fund vehicles or open-ended evergreen funds.
And importantly, drawdowns from open-ended evergreen funds, private asset funds, were many times lower than the drawdowns experienced on the listed close-end fund side. That's important because most investors will have come into this space not only looking for improved total returns, but also to improve portfolio resilience, diversification.
What we found on the listed closed-end fund market is that diversification and resilience is unreliable - it doesn't work in periods of extreme market stress.
James Lowe: What advice would you have for investors when you're looking at this landscape?
Solomon Nevins: In my previous firms, I managed strategies that had an allocation to both listed private asset strategies, investment trusts, and traditional private funds. So had the best of both worlds. What we found through that opportunity set was the private asset funds were much more resilient to periods of stress. 2022 was the classic example of that. While all listed or traded assets, including the traditional 60/40 equity-bond portfolio, fell very sharply, the private asset section of our portfolio held up very well and brought that resilience when we really needed it.
My takeaway from that experience was that having a core of true private assets within a multi-asset portfolio does bring that resilience.
Now, the closed-end fund market has opportunities for sure. When funds are trading at discount to the NAV, that presents the prospect for strong total returns as that discount to NAV compresses. There are some excellent managers on the closed-end fund side. But generally, we were looking to improve risk-adjusted returns, dampen volatility, reduce correlation to equity markets. That core to private asset funds was important.
For investors that have a long time horizon to invest in these areas and the flexibility to allocate to true private strategies, I think it makes a lot of sense.
James Lowe: Since you have previously built strategic asset allocations to private assets, can you share your insights?
Solomon Nevins: We had an assessment where we would invest across different private asset classes. We would allocate to those areas I have mentioned before, based on the expected risk-adjusted returns. We would calculate return forecasts, recognising that each of the asset classes sits along a risk spectrum. At the upper end, you've got private equity, venture capital; and at the lower end, you've got core infrastructure.
Depending on what investors are looking to achieve in their portfolio, the allocations to these different types of asset classes will vary. What we often see is that private assets is considered a risky asset class. From a liquidity perspective, that's correct. But in terms of your sensitivity to the economic cycle or to financial markets, that's not always true, or it certainly varies across asset classes, and that's the consideration investors need to make.
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