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June 17, 2024

The Evergreen Solution

Solving the Challenges of Closed-End Funds

June 17, 2024

The Evergreen Solution

Solving the Challenges of Closed-End Funds

Commentary

Private markets have the potential to increase returns and diversify risk away from public holdings. Yet they have historically been adopted primarily by institutions while private wealth Advisors have been slower to embrace these solutions. One key reason private wealth has lagged is the way funds that provide exposure to these asset classes have traditionally been structured.

Specifically, closed-end fund structures have been the most common method of accessing private equity, private debt and real assets. This investment vehicle has a discrete fundraising period where investors indicate their commitment to join the deal, but do not call the capital until an attractive opportunity is found. Investors choose when to commit, but managers control the pace of actual investment. Additionally, investors generally do not have any ability to redeem their purchase within the life of the fund and only receive cash upon exit of the underlying investments.

By contrast, evergreen solutions resolve these pain points experienced by private wealth by permitting periodic subscriptions and redemptions (subject to certain restrictions and conditions), and assuming responsibility for deploying and re-investing capital themselves. It is not a coincidence that evergreen solutions have become an increasingly popular fund format in private markets along the same timeline as asset managers turning to the private wealth channel for fundraising.

Impediments with Closed-End Funds

Closed-end funds can be difficult to implement within private wealth for three main reasons:

  • Long lockups—Typically closed-end funds have a life span of 10–12 years without on-demand liquidity. Not all private wealth clients are comfortable being locked into a product in which they can’t access their cash.

 

  • Committed not invested—The amount that is committed is not invested until the manager makes an investment. The Advisor will have to build a program for the money to be invested elsewhere so it doesn’t sit idle waiting for the manager to make a capital call. Since the capital call is a legal obligation with only a few days to fulfill, most Advisors will keep the money in liquid, cash-like investments.

 

  • Operational difficulty—Advisors bear the reinvestment risk in a closed-end structure. As distributions from exits are paid out to the investor, the capital is typically deployed back into the liquidity sleeve with a lower-than-expected return than the initial closed-end fund’s internal rate of return (IRR). Ensuring there are always closed-end deals available to redeploy the capital requires the Advisor to spend a significant amount of time to analyze and diligence new issues.
Close-up of a person planting a young fir tree in the forest.

The evergreen structure offers solutions for certain challenges Advisors face when trying to access private markets.

As there is no ability to redeem from a closed-end deal, an Advisor is not able to rebalance the portfolio. This can lead to the “denominator effect,” where the private market allocation exceeds the set threshold in the investment policy statement as public markets decline. Conversely, an Advisor can’t add profits from public markets back into the closed-end fund as the allocation has already been set.

Although closed-end funds certainly have a place in ultra-high net worth clients’ portfolios to attain a pure private markets exposure, there is another option to provide a more democratized entry point.

The Evergreen Solution

At BMO Global Asset Management (BMO GAM), we have developed open-ended private market funds otherwise known as “evergreens.”

The evergreen structure solves for some of the challenges Advisors face when trying to access private markets. By using a structure that is more Advisor-friendly for implementation, it will allow more retail investors to gain exposure to private markets.

The three main ways evergreen structures differ from closed-end funds:

  • Buy when you want, redeem when you need1—In a private markets evergreen structure, the Advisor can purchase monthly, meaning that all suitable clients will have exposure to the same fund regardless of when the Advisor brings the client on board. These evergreen structures also have built-in liquidity valves (subject to certain restrictions and conditions) which can allow the Advisor to make a redemption rather than having to wait for the underlying investments to exit. Although this structure will inherently have more cash drag for the liquidity sleeve, the trade off is that the investor can redeem with notice.2

  • Rapid capital deployment—Closed-end funds have historically been subject to capital call restrictions; an investor commits a certain dollar amount, however that capital sits idle until the manager requires it. In contrast, a dollar invested today in an evergreen will see that dollar deployed into the fund on Day 1. Evergreens can also experience a steadier IRR—that is, the rate of return on capital actually invested—because the fund strives to deploy capital from the time it is invested. The open-subscription model allows the manager to continue buying new assets, compounding returns over time.

  • Reinvestment risk shift from Advisors to fund—It typically takes four closed-end fund commitments a year to mimic the same cycle that an evergreen fund provides. This requires a lot of time for an Advisor to source, diligence and fund these investments, making it operationally difficult to bring across a book of business. For an evergreen fund to be successful, the manager must have an established platform of private market investments to continuously recycle the capital and originate new investments. This contrasts with a closed-end model, where once an asset is sold or position is exited, that money is then distributed out to investors and the Advisor is responsible for finding a suitable private markets investment.

    With an evergreen structure, the Advisor can rebalance portfolios as there is an ability to purchase more of the fund, or to redeem the fund with notice, subject to certain restrictions and conditions. By actively managing the portfolio, the Advisor is able to dynamically shift holdings when needed.

The BMO Advantage

We have taken the approach to partner with leading asset managers around the world with strong reputations and track records of managing evergreen structures. Our evergreen solutions are structured with liquidity channels and cash management that matches with the redemption features of the fund. Through our deep due diligence, we ensure the manager will have ample capacity to source new investments to mitigate reinvestment risk.

An example of a partnership in action, is with the BMO Partners Group Private Markets Fund—a one-ticket access to private markets. Subject to certain restrictions and conditions, it features liquidity to ensure cash is available for redemptions, which may not disrupt the fund’s long-term investment strategies. The Fund aims to provide competitive returns but also maintains a certain amount of liquidity, a rare combination in private market investments.

And we are just getting started. BMO GAM is committed to building solutions that offer broader diversification alongside potentially reduced volatility and enhanced returns for clients, by creating compelling complements to their public market portfolios.

For more information

Sources

Footnotes

1 Redemption requests are subject to specific terms of the Fund, and may be subject to certain restrictions, early redemption fees and redemption delays.

2 In the case of the BMO Partners Group Private Markets Fund, monthly redemptions are available with notice of 3 months (plus 5 business days) prior the relevant dealing day up to limits of 7.5% of fund’s net asset value per month, 20% per quarter and 25% per year. Subject to certain conditions, redemption payments will generally be made within 45 business days after the relevant dealing day. There is also a 2% early redemption fee in the first two years following the date of a unitholder’s initial subscription to the fund.

Disclaimers

BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.

 

The attached material is provided to you on the understanding that you will understand and accept its inherent limitations, you will not rely on it in making or recommending any investment decision with respect to any securities that may be issued, and you will use it only for the purpose of considering your preliminary interest in investing in a transaction of the type described herein. An investment in the BMO Partners Group Private Markets Fund (the BMO PG Fund) or any other alternative fund securities described hereby is speculative. A subscription for units of the BMO PG Fund or any other alternative fund securities should be considered only by persons financially able to maintain their investment and who can bear the risk of loss associated with an investment in the BMO PG Fund or an investment in any other alternative fund securities. Prospective investors should consult with their own independent professional legal, tax, investment and financial advisors before purchasing units of the BMO PG Fund or any other alternative fund securities in order to determine the appropriateness of this investment in relation to their financial and investment objectives and in relation to the tax consequences of any such investment. Prospective investors should consider the risks described in the confidential offering memorandum (OM) of the BMO PG Fund or in the relevant documentation for the offering of any alternative fund securities before purchasing units of the BMO PG Fund or any other alternative fund securities. Any or all of these risks, or other as yet unidentified risks, may have a material adverse effect on the BMO PG Fund’s business, another alternative fund’s business and/or the return to investors. Among other things, see “Investment Objective, Investment Strategy and Certain Risks” in the OM of the BMO PG Fund.

 

Certain statements included in this material constitute forward-looking statements, including, but not limited to, those identified by the expressions “expect”, “intend”, “will” and similar expressions. The forward-looking statements are not historical facts but reflect BMO Asset Management Inc.’s current expectations regarding future results or events. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. Although BMO Asset Management Inc. believes that the assumptions inherent in the forward-looking statements are reasonable, forward-looking statements are not guarantees of future performance and, accordingly, readers are cautioned not to place undue reliance on such statements due to the inherent uncertainty therein. BMO Asset Management Inc. undertakes no obligation to update publicly or otherwise revise any forward-looking statement or information whether as a result of new information, future events or other such factors which affect this information. Past performance is not indicative of future results or a guarantee of future returns.

 

“BMO (M-bar roundel symbol)” is a registered trademark of Bank of Montreal, used under licence.

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