Evergreen Thoughts - by Francesca Lloyd

March 2022

Evergreen structures tend to be polemic amongst infrastructure investors but there is a strong case for both open-ended and closed-ended infrastructure funds to co-exist. Those LPs that back evergreen structures, typically have long term liability matching plans and appreciate the relative ease that such structures could bring: no reinvestment risk with dividend reinvestment plans available, reduced vintage risk and stable cash yield over more unpredictable and reduced distributions. However, if an LP is investing from a closed ended fund structure themselves then evergreen structures are unlikely to align with their investment objectives and will not be considered. What is evident is that there is a large audience for both closed and open-ended structures. 

Evergreen structures can offer a liquidity profile which suits certain risk appetite and ALM restraints with the caveat that some redemption queues could be longer than a closed ended secondary process in certain market conditions; however building in wind-up provisions if redemptions are not satisfied by a certain period encourages fulfilment. Conversely subscription queues can delay LPs’ deployment with structural provisions to protect LPs from having GP’s take in too much capital in subscription windows.

From a GP perspective, an open-ended structure provides a permanent capital structure and the ability to plan and time market cycles with no forced entry or exit points. Evergreen structures suit the long-term nature of operating infrastructure assets, often enabling access to embedded growth opportunities that typically take years to realise. Similarly, evergreen owners can implement longer-term ESG strategies. However evergreen structures do not necessarily suit all infrastructure strategies; greenfield investments tend to be overlooked because the often associated J-curve does not marry with the longer term yield component, whilst the perpetual nature of such vehicles lends itself to more diversified strategies and not single sector plays. Evergreen structures have historically been associated with core infrastructure assets (early Australian funds are representative of this). However, if a manager is taking a 20+ year view, and assuming we are at an inflection point for infrastructure, what will be considered core in the future? Digitalisation, technological innovation and decarbonisation are redefining the infrastructure landscape and fund structures must be similarly adaptable, whether evergreen or fixed-term structures.

Beyond infrastructure, appetite for evergreen structures is increasing in the direct lending space. Evergreen structures particularly suit senior strategies. The relative limited risk of capital impairment borne by these strategies, combined with a solid pipeline of direct lending opportunities, and the ability to distribute coupons as steady recurring income, make them increasingly attractive as a core portfolio allocation (alternative to classic corporate bond investments), for which “fire and forget” structures are more desirable.  

There is a school of thought that believes evergreen funds fail to nurture innovation and entrepreneurship and are not suited to transformative opportunities. Creating the right alignment within such structures is a challenge, (how do you motivate, compensate and retain the investment team that sows the seeds decades earlier?); a thoughtful approach to vesting is required. Examples of such approaches include  designing a performance fee structure that recognises yield-based hurdles or accountancy performance  which isn’t retrospective (in contrast to those sometimes employed by longer hold closed ended structures as newly invested LPs shouldn’t pay a fee on uplift they haven’t received). We have also seen effective equity-issuing LTIP, on a whole firm approach, with set vesting periods based on annual Firm valuations.

If the alignment is well structured, an evergreen structure can give an LP comfort of additional manager accountability given the regular independent valuation process.  Further, fee sensitive LPs appreciate that the base fees can decline over time whilst encouraging growth; if fees are based on the lessor of drawn capital versus NAV.

Is there a place for evergreen structures going forward? Yes but one size does not fit all.