The burgeoning popularity of evergreen funds, a structure designed to offer investors liquidity while holding illiquid private market assets, has been met with significant challenges over the past year. These semi-liquid vehicles, once lauded for bridging the gap between traditional open-end funds and closed-end private equity, are now grappling with the inherent tension between investor demand for quick exits and the underlying nature of their portfolios. Recent redemption requests that outpaced stated caps, forcing some fund managers to implement drastic measures, have illuminated the vulnerabilities of this evolving investment landscape and spurred the development of innovative solutions.
The Redemption Squeeze: A Test for Evergreen Structures
In late 2023, concerns surrounding the underlying assets within private credit Business Development Companies (BDCs) triggered a wave of redemption requests that tested the limits of evergreen funds. These funds typically impose quarterly redemption caps, often set at 5% of Net Asset Value (NAV), to manage the liquidity mismatch inherent in their portfolios. However, as investor anxieties escalated, multiple fund managers found themselves facing redemption demands that significantly exceeded these pre-defined limits.
The responses from fund managers varied. Some opted to temporarily accommodate higher redemption levels, stretching their liquidity to meet investor demands. In a more decisive move, Blue Owl Corp. temporarily halted its quarterly redemption program, opting instead for periodic distributions. These distributions were funded through a combination of asset sales and the ongoing repayment of loans within their portfolios, signaling a more controlled approach to liquidity management.
While the initial surge in redemption requests has since subsided, and many private placement BDCs have managed to meet the majority of these demands, the episode underscored a fundamental challenge. Investors are increasingly attracted to the potential for ongoing access to private market opportunities offered by evergreen funds, yet the practical realities of illiquid underlying assets mean that immediate, full liquidity cannot always be guaranteed. This creates a delicate balancing act for fund managers striving to maintain investor confidence while adhering to the structural constraints of their funds.
Exploring Secondary Market Solutions: Beyond Redemption Caps
Historically, avenues for investors to exit evergreen funds outside of the scheduled redemption periods have existed, most notably for Net Asset Value (NAV) REITs. These real estate investment trusts, which also faced significant redemption pressures in 2023, have seen platforms like LODAS Markets (formerly Realto Inc.) emerge to facilitate secondary liquidity events for non-traded REIT investors. These platforms aim to create more active secondary markets, allowing investors to sell their holdings to other market participants.
Beyond these established platforms, private investment firms like Cox Capital Partners and Saba Capital Management have frequently stepped in during periods of redemption stress. These firms often make unsolicited offers to acquire oversubscribed shares at a discount. However, for the majority of investors, these discounts are often too substantial to make such transactions attractive. For instance, in March, Cox and Saba launched a tender offer to purchase 6.9% of shares in Blue Owl Capital Corporation II (OBDC II), a non-traded private credit BDC, at a proposed discount of 34.9%. Similar unsolicited offers targeting non-traded private credit BDCs managed by firms such as HPS Investment Partners, Apollo Global Management, and Ares Management, with average discounts around 26%, saw limited investor uptake.
Michael S. Covello, executive managing director at research firm Robert A. Stanger & Co., commented on this phenomenon, stating, "When investors can get redemptions at NAV, they generally do not view liquidity with large discounts to NAV as attractive versus waiting. Even in periods of heightened redemptions, they are getting redeemed, just not in full." This sentiment highlights the preference for NAV-based redemptions, even if it involves a waiting period, over accepting significant haircuts in the secondary market.
The Rise of Auction-Based Liquidity: A New Blueprint?
The landscape of liquidity solutions for private markets is continuously evolving. iCapital, a prominent alternative investment platform, has been actively working to integrate secondary liquidity capabilities into its ecosystem. Last year, the firm invested in Tangible Markets Ltd., a UK-based provider of liquidity solutions for private market positions, with the stated aim of creating an automated marketplace for financial advisors to trade illiquid holdings. However, this marketplace has yet to achieve widespread adoption.
A significant hurdle in establishing robust secondary markets for evergreen fund shares lies in the inherent difficulty of accurately valuing their private holdings. Kimberly Flynn, president of XA Investments, a firm specializing in tracking interval and tender offer funds, noted, "Where there is perceived demand, financial markets have a tendency to find a way to provide liquidity." However, she also pointed out the challenge: "Given their private holdings, it’s hard to determine what a ‘premium’ or a ‘discount’ to their NAV would be."
Chris Osmond, CIO of Fifth Third Wealth Advisors, which manages $7.8 billion in assets and invests in both evergreen and traditional drawdown structures, acknowledged the market’s drive for liquidity. He drew a parallel to continuation funds in private equity, which allow managers to hold onto prime assets for extended periods. However, he expressed caution regarding the introduction of a secondary market for evergreen funds, citing potential uncertainties around the accuracy of their NAVs, which are often perceived as lacking transparency. "Given the headlines and proration we have seen [in the evergreen space], I am not surprised to see the rise of this market," Osmond stated. "I see where providing some investor liquidity makes sense. But I also think that there would be some unintended consequences. Where I kind of struggle with this is the valuation aspect. Based off what valuation [is the secondary market operating]? Is it truly going to be NAV-based going forward? Is NAV truly accurate to what the value is?"
The Harrison Street Case Study: A Pioneering Auction
A significant development occurred in August, offering a potential template for how evergreen fund investors might access secondary liquidity during periods of proration. This event was a secondaries auction for shares of Harrison Street Real Estate Fund Class I (VCMIX), an interval fund with $1.35 billion in total assets. After its manager, Harrison Street Asset Management, had to cap redemptions for 15 consecutive quarters, the firm collaborated with Nasdaq Private Markets’ subsidiary, Nasdaq Fund Secondaries, and LODAS to conduct an auction. The objective was to provide an exit for the "loud minority of investors" seeking liquidity, according to Flynn.
Brian King, co-founder and CEO of LODAS, described evergreen funds as a "fantastic" innovation but acknowledged the public relations challenges that can arise when redemption requests exceed caps. He highlighted the persistent interest from institutional investors in participating in these vehicles. "It’s not a problem of lack of buyers and sellers; it’s how you get those two different parties to interact with each other," King explained. "What’s unique about what we built for this is we built an auction structure that helps find price discovery, but it allows [us] to do it in kind of a timed way, so everybody gets the same price; it all happens at the same time. Price discovery is incredibly important in this particular environment, and that’s what we were trying to solve for."
Nasdaq Private Markets had been exploring auction-based mechanisms for private market liquidity for several years, but the partnership with LODAS provided a crucial link to the wealth management channel. A 2019 whitepaper by Nasdaq outlined the benefits of auction formats for secondary liquidity in private markets, including familiarity for legal counsels and a more structured approach to pricing. However, it also noted drawbacks such as a lack of transparency in price discovery and forecasting difficulties.
The Harrison Street auction, the first intra-period auction in the evergreen fund industry, concluded on September 23rd. A remarkable 91% of the shares offered were sold, with 41% of sellers receiving a price higher than they had initially requested. The seller side comprised at least 10 Registered Investment Advisor (RIA) firms and 60 individual investors. The strong interest necessitated the development of a new tool by LODAS to facilitate bulk account openings for advisors on an expedited basis. The success of this initial auction led to the initiation of a second auction for the fund starting October 2nd, which reportedly generated "ten times the amount of interest we had for the first auction" on the buyer side.
The synergy between Nasdaq’s auction expertise and LODAS’s established network of potential buyers, particularly their experience in creating secondary markets for non-traded REITs like Blackstone’s BREIT and Starwood’s SREIT, was instrumental to the auction’s success. "You can have an auction, but if nobody is there to buy the funds at a discount, it’s kind of pointless," Flynn observed.
The Path Forward: Competition, Transparency, and Investor Education
The development of secondary marketplaces for private funds is gaining momentum. In October, LODAS partnered with the alternative investment platform CAIS to launch a secondary marketplace for private funds, aiming to leverage CAIS’s extensive network of over 2,500 wealth management firms and approximately 65,000 financial advisors. While CAIS clients did not participate in the Harrison Street auction because the interval fund was not yet approved on their platform, future auctions are expected to include them. LODAS and Nasdaq anticipate conducting auctions for an additional six interval funds by the end of the year, collectively facing redemption queues totaling approximately $13 billion.
A key advantage of auction pricing, according to Flynn, is its potential to provide sellers with "fair pricing." While acknowledging that discounts are a feature of secondary markets, she noted that "it’s not an arbitrage opportunity like you would find in the public equity markets because of the time and the risks involved, but there are reasonable secondary market buyers that would be willing to buy at a 10% or 15% discount." Craig Kilgallen, relationship manager at FUSE Research Network, concurred that increased competition in providing liquidity could lead to a compression of these discounts.
LODAS is committed to refining its auction process based on participant feedback, with the ultimate goal of creating a viable secondary market that significantly reduces discounts on evergreen shares traded outside of scheduled redemption windows. "Once people understand the process and how it works, I do believe we’ll be able to make them even better from a price discovery perspective, and overtime, build more transparency," King stated.
Max Curtin, senior analyst, fixed income strategies at Morningstar, views the auction approach as a prudent measure, potentially serving as an "insurance policy" for asset managers facing proration stress. However, he cautioned that managers who haven’t experienced significant redemption issues might not be quick to adopt secondary markets. Curtin emphasized the importance of investor education: "I think the most important thing is for investors to have clarity and understanding before they are entering into these vehicles in the first place that having an expectation of getting your money back whenever you want is unrealistic."
Despite these considerations, Flynn believes that establishing an auction format for the approximately 20% of evergreen funds that struggle to meet investor liquidity demands is in the best interest of all parties. She anticipates that as secondary markets mature, with broader participation and improved price discovery, the timetable for future auctions could accelerate, facilitating liquidity on an expedited basis. The Harrison Street auction has provided a tangible blueprint for enhancing liquidity in private market funds, addressing a critical need in an increasingly sophisticated investment landscape.
