Evergreen Funds: An open-ended operational tightrope

While the US has traditionally led the charge within the evergreen space, notably through open-ended funds structured under the ‘40 Act and more recently with significant growth in Business Development Companies, European evergreen funds are typically structured through Public Market Investment Trusts. As European regulators look to catch up with their US counterparts, there has been an emergence of additional structures such as the European Long-Term Investment Fund (ELTIF) and the Long-Term Asset Funds (LTAF). Since the announcement of the ELTIF 2.0 regime, the growth in number of ELTIFs has increased significantly with an estimated 150 active vehicles with an AUM of €20bn currently in the market.

These funds, while largely beneficial from an access and liquidity perspective, present their own risk and operational challenges to mitigate and manage.

What is Driving the Growth?

Growth in evergreen funds can be attributed to increased demand from private wealth investors for access to alternative and private market investments, and asset managers’ desire for permanent private capital – all facilitated by an evolving regulatory environment.

Evergreen funds provide access to continuous investment cycles and fixed periods of liquidity, creating opportunities for long-term stability and consistent allocations for institutional investors, as well as access to new asset classes for private wealth investors.

From a regulatory standpoint, European regulators demand stricter reporting and transparency from GPs, as increased investor protection measures are required to cater to private wealth and retail investors.

Operational Challenges

Against the backdrop of increasing popularity and evolving regulatory requirements, GPs are coming up against some notable operational challenges to manage evergreen funds:

1. Rising Investor Volume and Onboarding Complexities

A significant challenge with evergreen funds is the increased volume of investors to be continuously onboarded to the fund. Onboarding and KYC/AML for typical closed-end funds have historically not relied significantly on technology, rather driven by individual relationships and a predominantly manual approach to the review and management of governing documents, possible due to the lower volume of investors within such funds.

Investor onboarding is further complicated by the subscriptions and redemptions model which is not typically present in traditional closed-ended funds. As a result, GPs’ existing processes, technology and experience are not suitable for the evergreen funds, requiring a different operating model to meet investor requirements. This challenge is further complicated by the increased volume of investors, increasing from typically between 10-30 LPs, to possibly multiples of hundreds in evergreen funds.

Another key challenge present in the onboarding phase is obtaining sufficient data for Retail and Wealth investors who typically invest via a wholesaler through a nominee account. Given the nature of distribution networks for evergreen funds, and the difference in approach to closed-ended vehicles, there may be a lack of data availability which is critical for GPs to effectively manage liquidity management.

2. Liquidity Management and Redemption Complexities

While liquidity management is not a new topic to GPs, evergreens present additional liquidity challenges in the effective management of subscription proceeds balanced against redemption demands. Excess liquidity results in performance drag due to under utilised cash reserves, whilst also pressuring GPs to deploy capital quickly which may risk quality of investments and result in a divergence away from the fund’s investment strategy. On the flip side, insufficient liquidity can lead to shortfalls during periods of heightened redemptions, risking both regulatory and reputation damage to GPs across all types of investors.

In addition, the volatile behaviour of private wealth investors compared to institutional investors, further complicates liquidity management. Most GPs who manage closed-ended structures will have limited experience in completing liquidity management at the level of detail required for evergreen funds, relying on manual processes utilising incomplete data in Excel to complete tasks. To better address these challenges, industry leaders are employing dynamic liquidity planning and stress testing processes, including simulating redemption scenarios to evaluate their impact on portfolio liquidity to ensure adequate cash reserves.

3. Challenges in Valuations

Regulatory scrutiny is driving GPs to improve their governance and processes for valuations, with focus on ensuring inputs and assumptions within valuation models are robust and are regularly back tested to ensure the firm is using high quality data as inputs. This is a key focus area for the FCA when approving LTAFs, with significant importance placed on the skills and experience of people assigned with Valuation responsibility at the GPs.

In addition, the quarterly valuation structure for private markets assets and closed-ended funds creates a mismatch for evergreen funds which typically have monthly (or more frequent) product subscriptions. The inherent challenge of data collection and aggregation for private markets valuations requires GPs to utilise additional valuation techniques such as cash rolling and major event reaction to complete more frequent valuations and reduce the risk of error.

How to Address Operational Challenges?

As the technology landscape continues to evolve to meet the operational requirements of evergreen funds, it is critical for GPs to implement applicable technology platforms to remove the reliance on manual workarounds and inefficient processes whereby existing technology is not fit-for-purpose.

The industry has seen a rise in platforms dedicated to streamlining investor onboarding and investor AML/KYC processes, as well as platforms consolidating all investor activity and reporting functions within a single offering. Such platforms are aimed at supporting functional teams to increase the scale, transparency and insight of operations without creating undue processing burdens.

As firms look to address the portfolio and liquidity management challenges present, portfolio and investor data requirements must be at the forefront of GPs’ consideration when defining operating models. Given the complex and critical nature of such processes, GPs must ensure that in addition to technology implementation, those resources assigned portfolio management responsibility have the correct skills and experience to manage evergreen funds. This may require upskilling current resources or re-assigning responsibility from typical closed-ended processes to ensure operational requirements are effectively completed to meet fund and investor requirements.

Away from technology, collaborating with the right service partners, be it outsourced or offshored, to assist in the completion of repetitive and high-volume tasks, particularly around transfer agency and fund accounting, is crucial to achieving scalability across evergreen funds. Notably, industry leading service providers can offer experience and understanding of regulatory requirements and complexities across processes unique to evergreens, providing adaptable solutions and workflow automation as part of their fund administration services.

Conclusion

If you are an asset manager who has already launched an evergreen fund and are currently looking to optimise your operating model, or an asset manager considering launching an evergreen fund this year, then please reach out to discuss the above in more detail.