HarbourVest was interviewed on the topic in early August. And this news service is pleased to share more of HarbourVest's views about this important trend. 

To find out more about the firm and get in touch, go to this link.
 

The usual editorial disclaimers apply. To respond, email tom.burroughes@wealthbriefing.com 

Private markets have historically and consistently outperformed public markets, with time-weighted returns over rolling five-year periods,  showing private equity buyouts generating an average premium of 670 basis points over the MSCI ACWI Total Return (1).  Yet, investing in private markets has traditionally been reserved for institutional investors and ultra-high net worth individuals – investors who are able to meet the high investment minimums traditionally associated with private markets.

As regulation evolves and new products are launched, the door to private markets is opening. Structural barriers such as longer-term capital lock up periods that limit liquidity and the complexities and time required to create a private markets portfolio are being removed. More investors can now tap into the potential outperformance and diversification benefits offered by investing in private markets by making a single investment in an evergreen fund.

Read more about why private markets have the potential to provide outsized returns and how evergreen funds are changing the way investors can access this asset class.

Why private markets?
To understand how private markets can provide distinct benefits to an investor’s portfolio, it is important to consider the ways in which private markets differ from public markets.

A broader investable universe
When compared with public markets, private markets provide investors access to a larger and more differentiated opportunity set comprising a diverse range of companies at varying stages of development and growth. There are approximately 20 times more global private equity-backed companies than the companies included in the MSCI All-Country World Investable Market Index, the broadest public market index available (2). Globally, there are nearly 200,000 private equity-backed companies across buyout, growth equity, and venture investments (3), representing a wide range of companies from early-stage startups to more mature companies, along with a wide group of formerly publicly-traded companies which have decided to return to private ownership.

The ability to invest in a broader investable universe comprising many companies which are at earlier stages of growth, presents an opportunity for outsized returns. The exposure to small and mid-market companies offered by private markets is significant, with median private equity enterprise value projected at $243 million compared with the median public market capitalisation of $2.3 billion (4). 

More active engagement
Compared with their public market counterparts, private fund managers typically follow a more active and engaged approach with the underlying portfolio companies they acquire. They often have a controlling interest in the portfolio company and, therefore, the ability to influence the value creation strategy. The lack of publicly available information across a much wider investable universe creates the possibility for significant information asymmetry, allowing diligent and prudent private market investors the potential to optimise returns by influencing both the day-to-day operations and the longer-term value creation strategy of the portfolio company.

Value creation strategies
Because private fund managers are generally more engaged with their underlying portfolio companies, investing in private markets typically seeks to create return premia and potentially optimise returns for investors in three distinct ways:

Earnings growth
Value derived from operational improvements such as developing new products, synergistic M&A, and global expansion.

Multiple expansion
Buying smaller and/or public companies going through a tough time at a lower valuation and selling them at a higher multiple.

Debt reduction
Optimising the capital structure by adding and removing leverage effectively.

Risk/return benefits
While the broader macroeconomic environment influences private assets in a similar manner to public markets, as shown in the chart below, private equity (both buyout and venture) has historically generated meaningfully higher time-weighted returns and exhibited lower downside risk across all three time periods compared with public markets (MSCI ACWI). This dynamic is driven by a combination of active ownership which can provide support to portfolio companies in challenging markets, a preference for resilient businesses, and less reactive private markets valuations. Combining the potential for higher returns and lower downside risk, private equity can generate better risk-adjusted returns and provide diversification to an investor’s portfolio.

Accessing private markets via evergreen funds
Evergreen funds provide investors with a number of benefits when investing in private markets, as outlined below.

Immediate diversification
A private markets' investment programme should be diversified across several dimensions including sector, geography, vintage year, and strategy. Evergreen funds often invest in more than one private markets' strategy (secondary investments, direct co-investments, primary investments, etc.) and can provide diversification across a range of geographies and vintages, offering investors access to an established private markets' portfolio with a single subscription. Investing in an evergreen fund can remove the operational complexities associated with building a well-diversified and resilient private markets' portfolio “from scratch.”

J-curve mitigation
Private markets' investors often experience what is commonly referred to as the “J-curve” effect, or negative returns early in a traditional private fund’s life that become positive over time – giving the appearance of the letter J on a performance graph. Practically speaking, after an initial investment is made, portfolio performance is negative as capital is injected into the business without initial gain in value. Over time, and as investors continue to fund the commitment, gains begin to accumulate on the paid-in amount and investors can begin to harvest the gains by selling and realising interests once the total value of the investment is greater than the initial commitment. Investing in an established evergreen fund can mitigate the impact of the negative side of the J-curve and remove the cash drag of a typical 10 to 14-year closed-end private equity drawdown structure where early negative returns can weigh on performance early in the life of a private markets' commitment.

Manager access
There is a wide dispersion of returns across the private markets' manager universe, and access to many of the top quartile managers can be challenging. Top GPs, particularly within venture capital, are often oversubscribed and only grant allocations to investors with whom they have long-standing relationships. Furthermore, there can be significant upfront capital requirements to access top private equity managers during pre-set fundraising periods. Through a multi-manager or open-architecture approach, evergreen funds can provide investors access to multiple GPs in one investment. This can significantly reduce the time and research spent in having to find the best managers in each sub-investment class.

Snapshot comparison: Traditional private equity versus evergreen funds
With the evergreen market evolving quickly, there are many different options for new and existing investors to consider. Whether a single-manager or multi-manager product, and no matter the desired investment objective, we believe that proper execution of an evergreen strategy can accelerate outcomes for investors of all types. Thus, understanding evergreen fund product specifications and provider capabilities are crucial considerations for potential investors.

Evergreen funds are pioneering a new way to access private market returns. These funds seek to offer investors instant exposure to a diversified private markets portfolio in a single subscription with lower investment minimums, potential for enhanced liquidity, greater flexibility to meet investment objectives, and less operational complexity compared with traditional private markets' investing.

For individual investors, evergreen funds could well serve as a valuable complement to a public equity portfolio, an enhancement to an existing closed-end private markets' portfolio, or as an access point for investors new to private markets who wish to enhance risk-adjusted returns while preserving an option for liquidity if their personal circumstances change. Evergreen funds could also be used as a satellite liquidity solution for experienced institutional investors with a mature portfolio of closed-end traditional private equity funds seeking to adjust exposure back to a targeted strategic asset allocation level. Either way, evergreen funds are opening the door to private markets' investing, offering both new and existing investors access to potential outperformance and diversification benefits.

Footnote: 

1, MSCI data as of 30 June 2023. Calculated as the average spread of rolling five-year time-weighted global buyout funds return over rolling five-year MSCI ACWI total return. 31 December 2001 to 30 June 2023. Past performance is not a reliable indicator of future results.
2, Pitchbook, data as of 2 February 2024, and MSCI data as of 31 December 2023. Private markets comprising buyout, growth equity, and venture capital companies. Public market comprising all constituents in the MSCI All-Country IMI Index.
3, Pitchbook, data as of 2 February 2024.
4, Pitchbook and MSCI data as of 30 September 2023. PE backed companies include buyout, growth, and venture. Median PE enterprise value is defined as the sum of the absolute differences between private/public sector exposures for PE-backed deals invested for the period 2018 to 2022.

Disclosure

HarbourVest Partners, LLC is a registered investment advisor under the Investment Advisers Act of 1940. This material is solely for informational purposes and should not be viewed as a current or past recommendation or an offer to sell or the solicitation to buy securities or adopt any investment strategy. The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication, are not definitive investment advice, and should not be relied upon as such. This material has been developed internally and/or obtained from sources believed to be reliable; however, HarbourVest does not guarantee the accuracy, adequacy, or completeness of such information. There is no assurance that any events or projections will occur, and outcomes may be significantly different than the opinions shown here. This information, including any projections concerning financial market performance, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.The information contained herein must be kept strictly confidential and may not be reproduced or redistributed in any format without the express written approval of HarbourVest.