Q&A: Liquidity in open-ended evergreen funds explained
Open-ended evergreen funds are gaining popularity with private investors. We explore pros, cons, and liquidity mechanisms.
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Private markets are a strategic play for long-term goals. Yet, life's unpredictability calls for flexibility, and that’s where evergreen semi-liquid funds can come in handy. They can give private investors that extra flexibility compared to traditional private market fund structures, by providing access to their capital through specific liquidity mechanisms. It's key to remember, though, that this liquidity is a designed feature that comes with limitations, as private markets are inherently illiquid.
What are the key pros and cons of using semi-liquid funds?
Pros | Cons |
Flexibility for investors to enter funds or redeem capital at predetermined intervals. | Less liquid than public market investments. |
Periodic liquidity events provide opportunities for timely redemptions. | Not all investment strategies are suitable to be structured in a semi-liquid format |
Invested from day one and stays invested. Returns from asset sales are reinvested into new investments, so the investor maintains good exposure to the strategy without having to monitor and manage their investment across multiple funds and vintages. | May face increased redemption requests, which can strain liquidity management. |
Smaller subscription minimums, so more accessible by a broader number of private investors, as well as a much simpler subscription process. | |
Investment diversification with a low ‘blind pool’ risk – referring to the unquantifiable risk associated with committing to investments that are yet to be made, as is the case in traditional private market funds – as investors buy into an established portfolio. | |
Less price volatility than a listed closed-ended investment trust, where the share price is often at a discount to net asset value (NAV) and will vary according to the stock market fluctuations. |
How does liquidity work in semi-liquid funds?
Open-ended evergreen funds have built-in liquidity mechanisms to address potential mismatches before significant issues arise. These mechanisms depend on the fund and the underlying assets. Typically, liquidity is managed through portfolio construction, and the use of specific liquidity management tools.
How can portfolio construction be used to manage liquidity?
A well-constructed portfolio can offer a prudent spread of risk to avoid concentration. It might be exposed to different investment vintages, geographic areas, asset classes, and sectors. Most open-ended evergreen funds additionally maintain a ‘liquidity buffer’, meaning they hold a portion of the portfolio in more liquid assets, including cash, which can be realized more readily to meet redemptions.
Source: Schroders Capital.
What are the key liquidity management tools?
Liquidity management tools include: extended notice periods that allow the manager time to plan for redemptions; redemption limits (usually 5% of the NAV); lock-up periods for initial investments; minimum holding periods; and special dealing procedures after a suspension period. These tools offer flexibility to fund managers in managing liquidity and protecting shareholders' interests.
What happens if an investor’s circumstances change, and they need to get their money back?
Redemptions are managed through a combination of factors: the high level of cash flow delivered by the private assets (e.g. private equity, infrastructure), a modest holding of liquid assets and, if needed, the ability of the fund manager to sell stakes in private assets to the large and growing marketplace of buyers and sellers.
In some semi-liquid funds, redemption requests are first netted off against subscriptions received in the same period. If there is a net outflow, it will be funded from the fund’s liquidity buffer. If redemptions for the quarter exceed an established threshold, then the redemption request can be reduced pro rata, with the amount not dealt rolled into the next dealing day unless cancelled by the investor.
How often can investors access their capital?
This depends on the fund. Some offer monthly, while others offer quarterly redemptions. This means that price volatility should be lower compared to a closed-ended fund that is priced daily.
When and why would fund managers ‘gate’ a fund?
While it is a measure of last resort, semi-liquid funds might use gating provisions to limit the amount of assets that investors can redeem at any given time, thereby preventing a large number of investors from withdrawing their money at once. These provisions are designed to protect investors by removing the risk of having to engage in a ‘fire sale’ of assets, and this should be made clear to them when they’re subscribing.
Note that these liquidity mechanisms may introduce additional risks and limitations. Fund structures and their liquidity mechanisms can also vary depending on the jurisdiction and regulatory framework.
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