The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

By Jonathan Guilford and Neil Unmack

NEW YORK/LONDON, Feb 12 (Reuters Breakingviews) - Fundraising in the private-markets business can be tough. Wining and dining big investors for each new vehicle creates an endless treadmill. Worse, the typical closed-end fund structure ignores individual investors, locking out trillions of dollars of private wealth.

Enter “evergreens,” or vehicles with no set expiration date. They’re part of a broader fast-growing group of funds that plough money into alternative assets but still allow investors periodic withdrawals, and which now oversee some $420 billion, according to Preqin. While they are nice earners for Blackstone BX.N, KKR KKR.N and others, the increasingly popular structure jars with the investments’ fundamentally illiquid nature.

Buyout firms traditionally rely on closed-ended funds, which call up investors’ money over several years and then return it along with most of the investment profit within a decade or so. The model is struggling, however, amid high rates and choppy markets, which have left private equity managers sitting on $3 trillion of unsold assets. That means the underlying investors aren’t getting much money back from older vintages, making it harder for them to seed new ones. Closed-end funds’ illiquidity and high required minimum investments, meanwhile, shuts out individual investors with about $150 trillion of wealth, based on Bain & Co. estimates.

To forward-thinking buyout barons, those problems point to a solution: a continuous vehicle, with lower ticket sizes, and which gives investors the right to withdraw limited amounts of money. With these semi-liquid funds, Steve Schwarzman’s Blackstone and Henry Kravis’s KKR can just launch one vehicle and then skim off management fees indefinitely. Even better, the structure works for wealthy retail investors rather than just institutional clients, meaning buyout barons can get a slice of the $13 trillion of assets that Bain & Co. reckons individuals will have in private markets by 2032.

Blackstone cracked the code first. Its BREIT vehicle allows affluent individuals to buy into a real-estate portfolio for as little as $2,500. Established in 2017, it rocketed up to $70 billion in net asset value by late 2022. Credit-focused $68 billion BCRED came next. Schwarzman’s shop also has evergreen vehicles targeting institutional investors, including $43 billion Blackstone Infrastructure Partners, which charged a colossal $1.2 billion in fees last quarter after a multi-year buildup. Rivals have followed with their own products, meaning that major players’ assets under management are increasingly perpetual and semi-liquid in nature.

One problem is marrying illiquid assets with investors’ need to cash out. That’s easier for institutional-focused evergreens, where managers can use a range of techniques including a queue system, where fund investors can leave if new ones come in. Retail investors demand more flexibility. BREIT allows them to withdraw, in aggregate, up to 2% of the fund’s asset value per month or 5% per quarter. Schwarzman’s BCRED and KKR's KREST real-estate fund only allow quarterly withdrawals, subject to caps. The limits stop everyone from rushing to the exits at once and causing a fire sale.

Yet even maintaining limited levels of liquidity means holding a melange of cash and government bonds. These “liquidity sleeves” can comprise up to 20% of the portfolio for a retail-focused vehicle. Combine that with a typical 5% quarterly withdrawal cap, and the implication is that managers can meet investors’ redemptions for a year, before factoring in asset sales or cash flows form the underlying investments. Still, the liquid investments generally have lower returns than private assets, dragging down performance.

And BREIT, which had to gate withdrawals for 16 months after rates shot up in 2022, shows that liquidity sleeves are no panacea. The Blackstone vehicle eventually got some help from the University of California, in the form of a $4.5 billion slug of cash, but that’s not an option for smaller managers. BREIT’s wobble looks even more awkward for the newer range of evergreen funds focused on buyouts – an asset class that is arguably even less suited to offering liquidity.

Examples include Coller Capital’s CollerEquity or CAPM, run by Carlyle’s CG.O AlpInvest. They often plunge money into second-hand stakes in older funds, or make fresh investments in other managers’ new vehicles. Holding mature buyout assets, which are typically closer to being sold, helps to tackle the liquidity problem. Other funds, like Blackstone’s BXPE or KKR’s K-PRIME, focus more on the manager’s own deals rather than grabbing a slice of rivals’ ones. That puts them in charge of their own destiny, but they’re still generally co-investors alongside the traditional closed-end funds.

For evergreens to truly flower, they’ll need to post typical private-market style returns, despite the drag from holding extra liquid assets. The vehicles’ perpetual nature arguably helps in this regard. It means that investors can avoid the dreaded “cash drag” that plagues typical closed-end funds, where backers commit cash and then wait as long as five years before buyout barons are ready to spend it. KKR has calculated that, by avoiding this effect, evergreens could hypothetically compensate for their lower underlying investment returns.

This trick only works, though, if perpetual fund managers keep their vehicles fully deployed. That could lead to ill-timed investments – a danger that’s compounded by the possibility of being forced to sell assets to meet redemptions. Private-equity evergreens look most at risk, since Bain & Co. reckons that around half of the industry’s uplift from selling portfolio companies comes from taking advantage of higher valuation multiples, which is partly down to market timing. Indeed, across other asset classes there’s some evidence that closed-ended funds outperform open-ended ones: in the United Kingdom, traditional vehicles beat their perpetual peers in 11 out of 15 categories over the last 10 years, according to data from the Association of Investment Companies.

Success could bring more problems, for example by driving up competition for deals and therefore the prices buyout barons pay. The private equity industry already holds over $2 trillion of unspent dry powder, Preqin reckons, which would rise quickly if semi-liquid vehicles continue their recent growth. The blooming of evergreens is a gift for growth-hungry private asset managers, but it raises the thorny issue of how to manage all the new money.

Follow @JMAGuilford and @Unmack1 on X

(Editing by Liam Proud and Streisand Neto)

((For previous columns by the authors, Reuters customers can click on GUILFORD/ and UNMACK/Jonathan.Guilford@thomsonreuters.com neil.unmack@thomsonreuters.com))