In this final installment of our Private Markets Due Diligence blog series, we’re highlighting some important questions to ask when evaluating evergreen funds, specifically those related to valuation and deal allocation, as well as (everyone’s favorite topic) fees.
We won’t belabor the point on these too much, but it’s necessary to understand fund managers’ valuation and deal allocation practices because these are important parts of how evergreen funds are structured. In public markets, valuing the portfolio is simple and is done daily – private companies obviously don’t operate this way, so this presents a challenge. Most funds will produce a monthly NAV, but how that NAV gets calculated can vary, so the following can be useful questions to ask:
- Are the assets valued internally or by a third party?
- How often do the assets get valued?
- If using GP numbers, do you adjust them at all to account for market conditions or do you just assume their mark on a quarterly basis?
Regarding allocation, the aim should be to get to the bottom of whether the fund has access to all firm deals, or if it’s more narrow in scope. As an investor, you’d likely want access to all deals in which the firm could invest, provided they meet the goals of the fund broadly. The following questions can help with that analysis:
- How do the deals get allocated across the firm for this fund in relation to the other strategies your firm manages?
- Are there other funds or investment vehicles that supersede the Evergreen strategy?
- Does the fund have access to all deals or are there specific deals allotted to the evergreen strategies you manage?
- What share of deals do your evergreen funds receive?
Trying to get to the bottom of fees in any fund can be challenging, and evergreen funds are no exception. Here are a few things to consider:
- Beware of the headline fee. Some funds may have a low management fee, but once all of the add ons are layered in, it can result in a very different number.
- Make sure to assess double layers of fees. If a fund uses primary funds, those typically carry fees that may not be part of the explicit evergreen strategy fee, but will weigh on returns over time. Often times, primaries strategies add the more traditional ‘2 and 20’ economics on top of the evergreen vehicle fee. Comparatively, evergreen funds that rely mostly on direct and co-investment transactions, is likely to be more fee efficient.
- Remember that secondaries typically also include a second layer of fees. Ask questions around those fees, and also inquire as to whether the manager is able to renegotiate lower fees or could potentially do structured secondaries that can sometimes come with lower fees.
- Does the fund have an incentive fee? If so, how is it calculated?
- If it is calculated on a quarterly basis on both realized and unrealized gains, you’ll want to pay special attention to the fund’s valuation process.
There has certainly been a race to the bottom in public markets as far as fees go – and that is certainly a boon for investors. Lower fees overall means more return for you to enjoy. But in the private markets, at least for now, that’s not the case. Costs to transact are higher and barriers to entry are higher. Private markets are also not ‘efficient’ like the public arena. Access, deal flow and information are not necessarily created equal in the private landscape. Thus, simply looking for the lowest cost option may not add the same value as it does in public markets. Are low fee strategies getting the best deals? Do you have to pay up to partner with top-tier managers?
In private markets, the dynamics can be a bit different and sometimes the adage of ‘you get what you pay for’ does ring true. Many of the funds available today are pretty similar when it comes to all-in fees, so until these markets become as democratized as public markets there may not be much difference. However, for now, spending more time on understanding the fees and the incentives the different structures may create for managers is potentially more important than on which evergreen fund option is 15 basis points cheaper.
Evergreen strategies represent an area of the market that is growing and will likely continue to grow, and much like any attractive investment opportunity, entrants will be coming in year after year with new pitches, ideas and approaches. Evaluating funds in this space can share some similarities to public markets, but there are crucial differences to account for and nuances to understand.
We hope this due diligence series has helped shed some light on important considerations and questions to ask as you consider the space. If you would like to discuss private markets or due diligence on these types of funds in more detail, please don’t hesitate to reach out to us. We are happy to help.
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