Strategy insights 
Evergreen funds: Accessing private markets alpha
April 22, 2024
April 22, 2024 | 6 min read
Private markets have historically and consistently outperformed public markets, with time-weighted returns over rolling 5-year periods showing private equity buyouts generating an average premia of 670 basis points over the MSCI ACWI Total Return.1 Yet, private markets investing has traditionally been reserved for institutional investors and ultra-high net worth individuals – investors who are able to meet the high investment minimums traditionally associated with private markets.
As regulation evolves and new product innovations are launched, the door to private markets is opening. Structural barriers such as longer-term capital lock up periods that limit liquidity and the complexities and time required to create a private markets portfolio are being removed. More investors can now tap into the potential outperformance and diversification benefits offered by private markets investing by making a single investment in an evergreen fund.
Read more about why private markets have the potential to provide outsized returns and how evergreen funds are changing the way investors can access this asset class.
Why private markets?
To understand how private markets can provide distinct benefits to an investor’s portfolio, it is important to consider the ways in which private markets differ from public markets.
A broader investable universe
When compared to public markets, private markets provide investors access to a larger and differentiated opportunity set comprised of a diverse set of companies at varying stages of development and growth. There are approximately 20 times more global private equity-backed companies than the companies included in the MSCI All-Country World Investable Market Index, the broadest public market index available.2 Globally, there are nearly 200,000 private equity-backed companies across buyout, growth equity, and venture investments,3 representing a wide range of companies from early-stage start-ups to more mature companies, along with a wide group of formerly publicly traded companies that have decided to return to private ownership.
Sizing the private markets opportunity set
Source: PitchBook data as of February 2, 2024, and MSCI data as of December 31, 2023. Private markets comprised of buyout, growth equity, and venture capital companies. Public market comprised of all constituents in the MSCI All-Country IMI Index.
The ability to invest in a broader investable universe comprised of many companies which are at earlier stages of growth, presents an opportunity for outsized returns. The exposure to small and mid-market companies offered by private markets is significant, with median private equity enterprise value projected at $243 million compared to the median public market capitalization of $2.3 billion.4
More active engagement
Compared to their public market counterparts, private fund managers typically follow a more active and engaged approach with the underlying portfolio companies they acquire. Often, they have a controlling interest in the portfolio company and, therefore, the ability to influence the value creation strategy. The lack of publicly available information across a much wider investable universe creates the possibility for significant information asymmetry, allowing diligent and prudent private market investors the potential to optimize returns by influencing both the day-to-day operations and longer-term value creation strategy of the portfolio company.
Value creation strategies
Because private fund managers are generally more engaged with their underlying portfolio companies, private markets investing typically seeks to create return premia and potentially optimize returns for investors in three distinct ways:
Earnings growth
Value derived from operational improvements such as developing new products, synergistic M&A, and global expansion
Multiple expansion
Buying smaller and/or public companies going through a tough time at a lower valuation and selling them at a higher multiple
Debt reduction
Optimizing the capital structure by adding and removing leverage effectively
Risk/return benefits
While the broader macroeconomic environment influences private assets in a similar manner to public markets, as shown in the chart below, private equity (both buyout and venture) has historically generated meaningfully higher time-weighted returns and exhibited lower downside risk across all three time periods compared to public markets (MSCI ACWI). This dynamic is driven by a combination of active ownership which can provide support to portfolio companies in challenging markets, a preference for resilient businesses, and less reactive private markets valuations. Combining the potential for higher returns and lower downside risk, private equity can generate better risk-adjusted returns and provide diversification to an investor’s portfolio.
Private markets performance remains strong relative to public markets
Time-weighted returns
Higher returns
Downside risk
Lower downside
Risk-adjusted returns
(Sortino ratio)
Better
risk-adjusted returns
Source: MSCI and S&P Capital IQ data as of June 30, 2023. All returns in USD. Downside risk represents maximum peak-to-trough drawdown over the stated period. Past performance is not a reliable indicator of future performance.
Accessing private markets via evergreen funds
Evergreen funds provide investors with a number of benefits when investing in private markets, as outlined below.
Immediate diversification
A private markets investment program should be diversified across several dimensions including sector, geography, vintage year, and strategy. Evergreen funds often invest in more than one private markets strategy (secondary investments, direct co-investments, primary investments, etc.) and can provide diversification across a range of geographies and vintages, offering investors access to an established private markets portfolio with a single subscription. Investing in an evergreen fund can remove the operational complexities associated with building a well-diversified and resilient private markets portfolio “from scratch.”
J-curve mitigation
Private markets investors often experience what is commonly referred to as the “J-curve” effect, or negative returns early in a traditional private fund’s life that become positive over time – giving the appearance of the letter J on a performance graph. Practically speaking, after an initial investment is made, portfolio performance is negative as capital is injected into the business without initial gain in value. Over time, and as investors continue to fund the commitment, gains begin to accumulate on the paid-in amount and investors can begin to harvest the gains by selling and realizing interests once the total value of the investment is greater than the initial commitment. Investing in an established evergreen fund can mitigate the impact of the negative side of the J-curve and remove the cash drag of a typical 10-14-year closed-end private equity drawdown structure where early negative returns can weigh on performance early in the life of a private markets commitment.
Manager access
There is a wide dispersion of returns across the private markets manager universe, and access to many of the top quartile managers can be challenging. Oftentimes, top GPs, particularly within venture capital, are oversubscribed and only grant allocations to investors with whom they have long-standing relationships. Furthermore, there can be significant upfront capital requirements to access top private equity managers during pre-set fundraising periods. Through a multi-manager or open-architecture approach, evergreen funds can provide investors access to multiple GPs in one investment. This can significantly reduce the time and research spent in having to find the best managers in each sub-investment class.
Snapshot comparison:
Traditional private equity versus evergreen funds
With the evergreen market evolving quickly, there are many different options for new and existing investors to consider. Whether a single-manager or multi-manager product, and no matter the desired investment objective, we believe proper execution of an evergreen strategy can accelerate outcomes for investors of all types. Thus, understanding evergreen fund product specifications and provider capabilities are crucial considerations for potential investors.
For illustrative purposes only and not a complete list of differences.
Evergreen funds are pioneering a new way to access private market returns. These funds seek to offer investors instant exposure to a diversified private markets portfolio in a single subscription with lower investment minimums, potential for enhanced liquidity, greater flexibility to meet investment objectives, and less operational complexity compared to traditional private markets investing.
For individual investors, evergreen funds could well serve as a valuable complement to a public equity portfolio, an enhancement to an existing closed-end private markets portfolio, or as an access point for investors new to private markets who wish to enhance risk-adjusted returns while preserving an option for liquidity if their personal circumstances change. Evergreen funds could also be used as a satellite liquidity solution for experienced institutional investors with a mature portfolio of closed-end traditional private equity funds seeking to adjust exposure back to a targeted strategic asset allocation level. Either way, evergreen funds are opening the door to private markets investing, offering both new and existing investors access to potential outperformance and diversification benefits.
Would you like to discuss evergreen solutions and how they can play a role in your portfolio?
Footnotes
- MSCI data as of June 30, 2023. Calculated as the average spread of rolling 5-year time-weighted global buyout funds return over rolling 5-year MSCI ACWI total return. 12/31/2001-6/30/2023. Past performance is not a reliable indicator of future results.
- Pitchbook, data as of February 2, 2024, and MSCI, data as of December 31, 2023. Private markets comprised of buyout, growth equity, and venture capital companies. Public market comprised of all constituents in the MSCI All-Country IMI Index.
- Pitchbook, data as of February 2, 2024.
- PitchBook and MSCI data as of September 30, 2023. PE backed companies include buyout, growth, and venture. Median PE enterprise value is defined as the sum of the absolute differences between private/public sector exposures for PE-backed deals invested for the period 2018-2022.
Disclosure
HarbourVest Partners, LLC is a registered investment adviser under the Investment Advisers Act of 1940. This material is solely for informational purposes and should not be viewed as a current or past recommendation or an offer to sell or the solicitation to buy securities or adopt any investment strategy. The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication, are not definitive investment advice, and should not be relied upon as such. This material has been developed internally and/or obtained from sources believed to be reliable; however, HarbourVest does not guarantee the accuracy, adequacy, or completeness of such information. There is no assurance that any events or projections will occur, and outcomes may be significantly different than the opinions shown here. This information, including any projections concerning financial market performance, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. The information contained herein must be kept strictly confidential and may not be reproduced or redistributed in any format without the express written approval of HarbourVest.
