The rise of the open-ended private equity “PE” fund, colloquially referred to as evergreens, has allowed retail investors who meet certain wealth or income thresholds to access what used to be an asset class that was exclusively available for institutions or very wealthy families. Although the technology is rather new, so far the results have not disappointed. 

Most, if not all private equity and venture funds are structured as drawdown vehicles. These types of structures are very long-term oriented, their typical life is 10 to 15 years, and are only open to qualified purchasers (individuals with +$5 million in investable assets). Besides, they do not typically offer redemption or liquidity features whereas the penalties to withdraw from such -if at all contemplated- can be severe. 

For new PE investors, ramping up and reaching allocation targets with these types of vehicles is also complicated and takes extensive time as a typical PE fund calls in average about 20% of investor capital commitments on a yearly basis. Besides liquidity, the other great risk these vehicles pose is underperformance and/or poor management, which is a particularly concerning factor given investors are typically locked up for the duration of the partnership and can’t turn into cash like in a periodic liquidity fund. 

Drawdown structures however are the preferred vehicle for private equity partnerships and there are clear reasons as to why. Mainly, it takes time and resources for private equity funds to find the right targets to acquire and months to negotiate and close on a deal. Thus, investors are better off keeping the cash in their own accounts -and potentially invested in something else- while the GP finds good opportunities to buy into. 

Private Equity though has grown and evolved since its inception about 50 years ago. It is still a young industry that nowadays plays a very large role in the US economy and touches cash-flow positive companies of all shapes and sizes, from a business installing roofs in South Florida to those with global presence worth billions of dollars.

Today, even though PE funds universally employ the drawdown structure, two byproducts of the primary PE industry have grown into their own ecosystems: co-investments and secondaries. Co-investments supply pools of passive equity to top-off the capital needed to complete a fund acquisition. These opportunities exist because of hard-capped fund sizes and diversification rules. Secondaries on the other hand facilitate liquidity to fund partners, “LP’s”. For example, an investor with a portfolio of mature drawdown funds could seek to sell his partnership interests through a specialized secondaries broker, typically at a discount from NAV. 

The evolution of the perpetual fund.

Some of the first perpetual private equity funds actually experimented with committing into drawdown funds and keeping cash invested in money market instruments while capital was called on the commitments. However, the cash drag on these instruments was significant, diluting the returns that the underlying funds would have achieved on their own. 

The evolution and growth in volume of secondaries and co-investment opportunities has allowed institutional private equity allocators to buy into pools of PE-operated assets, making them suitable for perpetual fund of funds “FoFs” that are continuously raising capital and looking to deploy in parallel. Just for readers to have an idea of sizes, according to Evercore, the secondaries industry has gone from trading $26 Billion annually 10 years ago to a projected $140 billion in 2024. 

Setting up open-ended funds requires having relations with dozens if not hundreds of PE funds that may be offering co-investment opportunities and a solid network of secondary brokers to find LP interests at the best discounts possible. Only a limited number of allocators have built the network of providers to access a robust pipeline of “buy” opportunities into high quality assets without risking cash drag or being pushed into lesser quality ones due to a lack of better options.

The formula is also being employed by some of the largest private asset managers in the world. Such firms nowadays have developed multiple strategies that cover different regions (North America, Asia, Europe, Growth, etc) and sectors (Health, SAAS, etc) and their significant deal count on a yearly basis allows for their own proprietary perpetual funds to co-invest alongside the main drawdowns of the firm and grow AUM in unison. These initiatives are still in their early stages but so far have been successful at raising large amounts of capital, particularly from the domestic US RIA channel, in part because of the established names promoting them. 

Does retail mean lesser performance or quality?

The Private equity industry and its institutional allocators setting up FoFs seem to finally have “cracked the code” to the open-ended PE fund with the evolution of secondaries and co-investments and the diversification of strategies within the largest PE firms. The technology is here to stay and we will see wider implementation. 

Investors with no PE exposure can now tap into very diversified pools of high-quality assets through one single fund, whereas in the past, investors would have had to commit to drawdown vehicles on a fund by fund basis, running the risk of poor performance and no exit avenues. Besides, investors in open-ended funds become immediately invested and are beneficiaries on day one to the performance of underlying assets. 

That is not to say that sophisticated and large investors should avoid drawdowns funds altogether, particularly if given the opportunity to invest into a great manager with a top quartile or decile record. The Venture Capital “VC” industry, for instance, which is also exploring how to tap wealth management money, is way behind private equity in creating open-ended funds. Investors seeking to start an allocation to VC would mostly be limited to accessing drawdown vehicles. Having said this, combining the two types of funds may be a good fit for qualifying investors and a great way to achieve high performing private asset allocations on day one.