An Evergreen Vehicle Can Be an Important Tool in Private Equity Asset Allocation

May 2024
5 minute read

Throughout the year, we'll be bringing you insights about private equity investing. From the basics of understanding the asset class to addressing key market issues to identifying what we think the benefits of the asset class are, we hope to cover many of our investors’ top questions and concerns. Our first piece focused on how private equity can succeed in a higher-rate environment. Here, we explore some of the benefits of evergreen private equity fund structures.

Institutional investors have been able to take advantage of the illiquidity premium and diversification benefits of investing a significant portion of their portfolio in private equity for several decades, but we are just starting to see broader adoption among individual investors. We think private equity is increasingly useful for these investors at a time when the positive correlation between stocks and bonds is elevated and expectations for future returns are lower.

There are many ways to access private equity, including diversified funds-of-funds, traditional drawdown funds, evergreen vehicles, and more. As evergreen vehicles proliferate and evolve, we have observed some structural advantages that investors may not be aware of, particularly when combined with traditional drawdown funds.

1. An evergreen vehicle can help individual investors achieve their desired private equity allocations faster and manage capital more efficiently.

A traditional drawdown fund can take many years to fully invest and reach a desired allocation. During that time, uncalled capital is typically held in public equities and bonds, cash or cash-like securities, or a combination of both. An evergreen vehicle, on the other hand, provides investors with an efficient means of immediately deploying into a diversified private equity portfolio and maintaining their exposure.

In an evergreen vehicle, capital is invested on day one into a vehicle with a current net asset value (NAV). That vehicle is, on average, 80%-90% deployed in existing private equity portfolio companies, with the remainder in a liquidity sleeve (Exhibit 1). Thus, the capital can generate returns from day one, while the vehicle also has the capacity to manage upcoming acquisitions and liquidity requests.

When the managers exit a position — for example, when a company is sold to a strategic or financial buyer or taken public, with the shares sold down over time— the resulting capital is automatically recycled into new deals. This limits the reinvestment risk that can force individual investors to be “out of the market” for a period after a realization in a traditional drawdown fund.

EXHIBIT 1: Private Equity Portfolio Allocations in Evergreen vs. Drawdown Vehicles

: Bar charts showing how private equity portfolio allocations evolve over time in an evergreen vehicle vs. a draw down structure. — Note: The above schedule is for illustrative purposes only. Diversification does not guarantee returns or capital preservation. Top chart assumes the evergreen vehicle is fully deployed and is representative of evergreen vehicles that exist in the market today.

2. An evergreen vehicle has the potential to outperform drawdown funds in an individual investor’s portfolio.

An individual investor can potentially achieve higher compounded returns (sometimes called multiple on invested capital, or MOIC) in an evergreen vehicle than a drawdown fund.

To achieve a MOIC of 3x over a 10-year period — meaning that, net of fees, investors walk away with three times more money than they invested — a typical drawdown fund would need to generate an 18.4% net internal rate of return while an evergreen vehicle could achieve the same MOIC from a net internal rate of return of just 11.6% (Exhibit 2b).

EXHIBIT 2a: Cumulative Value of Investing $100 in Evergreen and Drawdown Vehicles for 10 Years

A line chart showing the cumulative value of investing $100 in an evergreen vehicle vs. a drawdown vehicle over 10 years.

EXHIBIT 2b: Evergreen Structure Has the Potential to Deliver a Higher Net MOIC for an Equivalent Net IRR

A table showing a comparison of Net Multiple On Invested Capital (or MOIC) in an evergreen vehicle versus a drawdown fund. — Note: For illustrative purposes only. Assumes 10-year term. Modeled drawdown private equity fund assumes that capital is deployed in equal increments over a 5-year investment period and that investments are held for 5 years before their sale and distribution of capital to the limited partners. Undrawn capital is assumed to be held in a 60/40 portfolio of public equities and bonds generating a 6.8% return assuming a 5% return for bonds and 8% return for equities, which is the long-run historical returns of the MSCI World Index and Bloomberg Global Agg Index since 1990. Distributions from the drawdown fund are re-invested into that 60/40 portfolio. For the evergreen vehicle, it is assumed that all liquid capital is held in liquid credit, cash and treasuries generating a 5% return and the vehicle is fully deployed at 85% private equity deals and 15% liquidity sleeve. Assumes a net IRR of 13.5% for the Drawdown fund and private equity portion of Evergreen Vehicle. The net 13.5% IRR is illustrative of the Cambridge Global Private Equity Index from 2000 to 2019 (inclusive of all Global Buyout and Growth Equity funds).

How can this be? An evergreen vehicle is fully funded from day one to provide immediate exposure to a diversified portfolio. When capital is invested from day one, it begins compounding returns faster than a drawdown fund and results in a higher average allocation to private equity over a 10-year period, leading to higher compounded returns.

Evergreen vehicles offer a compelling proposition to individual investors who generally do not have access to a wide range of managers and the scale of capital needed to pursue more complex allocation and cash management strategies. Larger institutional investors often mitigate the “cash drag” problem by oversubscribing or having a team monitoring capital calls and reinvestments, but for individual investors with limited resources, an evergreen vehicle can be a more efficient way to stay invested in private equity.

3. Evergreen vehicles can potentially complement traditional drawdown funds.

Blending drawdown and evergreen vehicles may produce higher compounded returns and lower risk both in terms of reinvestment and diversification for individual investors, in our view. Unlike larger institutional investors, many individual investors are not able to access a wide enough set of drawdown vehicles to fully maximize their private equity allocation, often resulting in an underweight and concentrated portfolio focused on a handful of sectors, strategies or geographies.

In addition to allowing immediate compounding and a higher average allocation to private equity over a 10-year period, an evergreen vehicle will continue to acquire new portfolio companies after an investor invests in the vehicle under most circumstances. A growing portfolio of companies can bring material diversification benefits to a private equity portfolio, allowing investors to take advantage of many different vintages.

Investors may also use evergreen vehicles as a capital management tool. As drawdown funds produce realizations, investors can reinvest the proceeds immediately into an evergreen vehicle to maintain their desired allocation to private equity (Exhibit 3). As discussed earlier, maintaining a higher allocation to private equity over time can lead to material outperformance in both the short term and long term (Exhibits 2a and 2b).

Investors may wish to consider placing the evergreen vehicle as a “core” part of a private equity allocation allowing for a baseline level of deployment and diversification, while a “satellite” allocation to drawdown funds allows investors to diversify and gain additional exposure to different kinds of managers, strategies, or regions.

EXHIBIT 3: Blending Drawdown and Evergreen Structures Could Produce Higher Compounded Returns Over Time.

A bar chart showing how blending an evergreen vehicle with a drawdown structure has the potential to produce higher compounded returns over time. — Note: The above schedule is for illustrative purposes only. Diversification does not guarantee returns or capital preservation. Top chart assumes the evergreen vehicle is fully deployed. Table in bottom is using the same model as described in Exhibit 2. The ‘Drawdown Only’ scenario assumes that undrawn capital is held in the 60/40 portfolio and that distributions are re-invested into the 60/40 portfolio. The combination scenarios underneath assume that undrawn committed capital to the drawdown fund is held in the 60/40 portfolio. For example, in the 50% drawdown / 50% evergreen scenario, the day one allocation is 50% invested in the 60/40 portfolio and 50% in the evergreen vehicle. As capital gets called to the drawdown, that is sourced from the 60/40 portfolio. When the drawdown starts to make distributions, those distributions are re-invested into the evergreen vehicle. Return assumptions are the same as outlined in Exhibit 2.

4. It is important to invest with best-in-class managers.

Unlike the listed equity market, there is a significant dispersion of returns (a difference of 1,400 basis points) between top-quartile private equity managers and bottom-quartile managers (Exhibit 4). For that reason, we think it is important to select a manager that has a track record of performance through various cycles.

Investing is about recognizing patterns and creating your own luck as an investor. Though past performance does not predict future results, we believe that private equity managers with both experience across the economic cycle and time-tested tool kits to create value have a better chance of recognizing patterns they have seen before and repeating playbooks for value creation that have proven successful over time.

This may help investors maximize the return premium in excess of public equities that can be achieved over time.

EXHIBIT 4: Difference between Top-Quartile and Bottom-Quartile Managers Across Asset Classes

A chart showing how manager selection can impact various asset classes including US Fixed Income, US Equities, All Global Equities and Buyouts. — Source: eVestment Alliance database for 15‐year period through December 31, 2023. US Equities include large and small cap indexes; Preqin online database, performance as of December 2023 (includes vintages for the 16 years to 2021), top quartile, median, and bottom quartile boundary net IRRs. Performance for later vintage funds not available because the funds have not had adequate time to deploy capital, operate assets, and exit. Preqin’s database is continually updated and subject to change.

Summary

Evergreen vehicles can help investors manage their capital more efficiently and have the potential for improving returns over a drawdown fund alone. In our view, both evergreen vehicles and drawdown funds have a place in an investment portfolio and can help maximize performance and diversification.

An Alternative Perspective: Past, Present, and Future