Is Private Equity Finally Going Liquid?

Individual investors have often not been permitted the same access to private companies as public ones. Yet more than 80 percent of all companies are neither listed nor traded on the public markets.  

The good news is that owing to structural and regulatory developments, private equity investments are being opened up to more possibilities, with new formats available that are adapted to individual investors’ requirements.

Gad Amar, Head of Distribution for Western Europe, and Nicolas Audhoui-Darthenay, Head of Private Assets Product at Natixis Investment Managers, share their views on the benefits and limitations of so-called «evergreen» funds.

What are the expectations of retail investors when they choose private equity strategies?  

Gad Amar: First of all, it is important to remember that private equity is mainly aimed at investors who already own other asset classes in their portfolio (equities, bonds, derivatives and who are looking for additional sources of diversification and returns. 

In exchange for a higher target return and diversification benefits, private equity assets are inherently illiquid if held directly and require specific expertise as well as access to transactions. This is where the expertise of management companies comes into play, providing sourcing and structuring to offer a suitable solution. 

Retail investors are asking for flexibility in their investments, especially to deal with life events or any needs that may change over time. Closed-end private equity funds with multiple capital calls and holding periods of five to nine years do not meet those requirements.

The creation of open-ended or ‘evergreen’ funds investing in private equity that are accessible to individuals makes it possible to remove this obstacle in the democratisation of private assets. 

What liquidity constraints should be accepted when choosing this asset class?

Nicolas Audhoui-Darthenay: As opposed to traditional equity or bond funds that provide a daily net asset value (open-ended funds where the investor can enter or exit daily), an evergreen private equity fund can only offer limited liquidity with well-defined subscription and redemption windows, for example, monthly or quarterly.

The liquidity offered to end investors must also be adapted to the asset class, with two main families of evergreen private equity funds: funds whose liquidity is based on an insurer and those that manage their liquidity internally. 

The former typically offer regular liquidity (between weekly and monthly) with a small pocket of liquid assets. On the other hand, they are only distributed in life insurance and often within a captive network, for example, the life insurer of the same group or close to the management company of the fund in question.

This leads to a more limited supply for end investors with sometimes disappointing returns. 

For evergreen funds that manage their liquidity internally, this is made possible by the manager, who also selects assets based on their ability to generate regular positive flows and/or to be resold if necessary.

The counterparty is sometimes a larger pocket of liquid assets, historically around 30 percent in France, but a refined structure makes it possible to reduce the size of this pocket, for example, via funds of funds. In any case, these funds can be offered to all types of clients and are free from dependence on the life insurer, while remaining eligible for it according to the regulatory formats (FCPR Fonds Commun de Placement à Risque). 

To clarify, it is also possible to manage liquidity through an outflow limitation mechanism, such as gating. This mechanism can only be used on an exceptional basis on French funds (FCPR). The new European ELTIF (European Long Term Investment Fund) format allows this, but it is not without risk for end clients, who could find part of their savings blocked at a time when they need it.

It is therefore necessary to be cautious with ELTIF funds between those that have liquidity based on the fund's ability to generate flows and/or sell assets and those that offer liquidity mainly based on gating. 

Is the performance potential of evergreen funds, which are more liquid, lower than that of closed-end funds, which are reserved for institutional investors?

Nicolas Audhoui-Darthenay: Closed-end funds generally have only a marginal pocket of liquidity, but the individual investor keeps cash to meet the capital calls of closed funds and may have cash waiting to be reinvested at the time of the amortisation of these same funds. As a result, this investor suffers from a dilution of their real performance by this marginal liquidity in their account. 

Conversely, evergreen funds generally have a minority pocket of liquidity that allows the manager to cope with investor outflows. As the investor can more easily decide when to enter and exit from their investment, dilution due to cash in their account is almost non-existent.

In a way, for an individual investor, the dilution due to cash that is important at the beginning and end of the life of closed-end funds is replaced by a lesser but permanent dilution. 

As a reminder, the fund launch period excluded; money is immediately deployed in an evergreen fund, since the investor benefits from the fund's previous investments.

Whereas deployment can take several years for a closed fund, with significant waiting periods for liquidity for the end client. If the «domestic» liquidity pocket of an evergreen fund is optimised, the end client could have returns equal to or close to the actual returns of closed-end funds.

At Natixis IM, we are committed to optimising the size of the liquid pocket. Thus, funds can be structured with up to 80 percent invested in «pure» private equity. 

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