Private equity firms first pitched permanent capital funds as a way to hold on to great companies (almost) forever. Allocators viewed them as a way to get better alignment with general partners, the holy grail of private markets investing.
Even though asset owners have increasingly invested in evergreen structures, citing better deal terms and fees, these structures still pose challenges. The funds are a new concept and present a more difficult pitch for chief investment officers to make to their boards. And if a fund manager performs badly, it’s tough to leave them behind.
“The neat thing about an evergreen fund is that it’s another tool in the toolkit in figuring out how we build aligned structures,” Ashby Monk, executive and research director at Stanford Global Projects Center, told Institutional Investor.
Here’s how it works: A private equity firm raises capital from limited partners, as they would normally. Instead of setting a deadline for when the fund will return capital to investors, the fund is designed to hold onto it permanently. However, private equity firms generally offer investors some exit options in certain cases.
After selling a portfolio company, the private equity firm can reinvest — or recycle — the capital into a new investment, rather than returning it to their limited partners.
According to Christine Kelleher, head of investments at the National Gallery of Art, it's already rare for traditional private equity funds to return all capital to investors in ten or even 12 years, despite this being the typically promised time frame.
“Early in my career, when I was developing private investment program cash flow models, I asked a fund-of-funds manager what timeframe they use for venture capital funds,” she said. “My colleague laughed and responded that ‘three of our funds are now legal!’ — meaning, they had just crossed the 21-year mark.”
General partners at traditional private equity funds may also be too short-sighted. “Too often people manage these funds in a way that maximizes value to the fund,” he said. This could involve selling a company too early because of the fund’s limited life or paying more expensive transaction fees to finish a deal quickly.
Evergreen or permanent capital funds can lock up capital for a similar time frame but allow limited partners to avoid managing liquidity around irregular capital calls, and, as Kelleher said, the “drag of fees on committed but not invested capital.”
“They give the GP the flexibility to manage capital in alignment with an institutional allocator’s long-term investment horizon rather than being forced to sell assets because a fund is approaching the end of its term,” she added.
Asset Managers Happy to Meet Investors’ Demand
Asset managers are responding to these needs. In November 2020, for instance, Blackstone announced that it had raised $8 billion for its “long-held private equity vehicle,” the largest permanent capital fundraise in history, the firm claimed.
And in January, BlackRock announced that it had raised $3.44 billion for its long-term capital vehicle. The fundraise did not hit its initial target of between $10 billion and $12 billion, though. The California State Teachers’ Retirement System is among the fund’s more than 30 investors, its limited partnerships list shows.
Large funds don’t have a monopoly on the market, though.
Washington D.C.-based Cranemere Group, for instance, which snagged an investment from Alaska Permanent Fund in 2019, holds companies for the long-term. And NewSpring Capital, a firm based outside of Philadelphia, has a long-term lower middle market fund with a similar strategy.
Another example? California-based Generate, a clean energy infrastructure fund that aims to hold assets in an evergreen structure. The fund’s investors include Australia’s QIC and Alaska Permanent Fund. “It makes incredible sense especially when you move into infrastructure assets,” Monk said. “You don’t want to sell all of this stuff in seven years.”
The Funds Pose Some Potential Conflicts
But these funds are not without downsides — it can be hard to structure them in a way that avoids conflicts of interest.
“If you’re a private equity GP and you’re really happy with how much the fees are, you can lock investors in for 20 or 30 years,” Monk said. “It's not all that easy, especially if the manager doesn’t do well, to get in and out of these things.”
Plus, some allocators say they like the discipline a set fund life offers, Monk noted.
Once an asset owner decides to invest with a permanent capital fund, there’s another hurdle to get over: their board. While some investors are lucky to have board members who have long been in the industry, others, particularly public pension funds, have elected officials — some of whom can get political — on their committee.
“From the allocator’s perspective, the benefits of greater alignment and liquidity have to be weighed against the risk of recommending a unique fund structure to an investment committee,” Kelleher said. “Getting a new investment over the finish line is hard enough; introducing a complex liquidity structure can be a distraction.”