Episode 277: Breaking Down Evergreen Funds: Flexibility, Transparency, and Performance

 

Stewart: Welcome to another edition of the InsuranceAUM.com podcast. I'm Stewart Foley, I'll be your host. Hey, welcome back. It's great to have you. And the other day I was listening to a podcast and the host actually came on and talked about what the purpose of the podcast is, which I've never really done that before. So I think it's important for you to know that the purpose of our podcast and what we tell all of our guests is that these are educational shows that are really designed to help with the professional development of insurance investment professionals in the US and elsewhere. Our audience has been very consistent. It's a concentrated group of insurance investment professionals, and I guess what I'd ask is if you know a person who you think might be interested in our show, please share it with them. You can get the link off of any word that you get your podcast, and we want to make sure that everybody knows what we're trying to do here.

So today's topic is Evergreen Funds: A Compelling Tool for Private Markets, and we're joined by Fabian Körzendörfer, who's a partner with the StepStone Private Debt research team. Fabian, thanks for being on. You're joining us from Switzerland. Very happy to have you and thanks for taking the time. 
Fabian: Thanks for having me, Stewart. Excited to be on the show.

Stewart: Just a chance for you to talk shop and educate our audience here a little bit. But before we get going, we want to get to know you a little bit. So where did you grow up and what was your first job? Not the fancy one.

Fabian: I love this question in your show. It always provides a great segue into the personality of your podcast partners. And myself, I grew up in a very rural part of Bavaria, which is in southern Germany, Europe, really small town. I graduated from high school there and then studied economics in Munich. After I graduated from university. It was the early 2000s, i.e. right after the global financial crisis. So this was a very interesting time to start a career. I actually joined a couple of advisors advising private equity firms, investing into banks, insurance companies, and similar financial institutions. And I was mainly looking into working out loan portfolios on their behalf.

So I saw a lot of things that went wrong during that time, what to look out for. Very interesting years. And then in 2016, I decided that I would like to move more from an advisory capacity into more of an investment decision-making view. And this is the reason why I joined StepStone in 2016 in their private debt business. Back then, to be honest with you, private debt was a bit of a different asset class, much smaller than it is nowadays. We were around 10 people within the investment team and we had a couple of billion to manage, which already back then was quite a lot, but it has grown very substantially from there. So fast-forward to 2025, I'm working in an industry that oversees around $1.7, $1.8 trillion of investments, which has been a very exciting journey for me.

Stewart: That's super cool. I also want to mention you are a CFA charter holder. I always want to point that out. For those of us who've been through that process, it's valuable. So if you would, I'd love to start with the basics, and to be honest with you, this is a question that I don't know the answer to. So that's the basis of it, which is can you give us an introduction of what evergreen funds are, what they are, what they aren't, and why are they becoming increasingly relevant in today's market?

Fabian: Yeah, contrary to popular belief, evergreens are not only plants that have leaves all around the year, but they're also funds that are specifically targeting individual investors that have really emerged over the last couple of years, these type of funds. They provide a couple of significant advantages, especially when it comes to convenience, efficiency, and transparency.

Private markets have mostly been invested over the last decades via drawdown funds, so funds that are issuing capital calls which are not necessarily very predictable and fairly volatile. You have an investment period over which you can draw this type of capital. Typically, you end up being drawn 70% to 80% after 3 to 5 years. That's at least true for the private debt asset class and thereafter the funds go into runoff.

This has been a significant burden for private investors, fairly complex to manage their cash flows. They also had other issues. For example, many of these funds required a fairly high minimum investment amount, typically 1 million or above, and their tax reporting was all messed up through these type of funds. So the industry has basically started to address these concerns through the evergreen fund world. What does Evergreen mean? These are funds that are offered on a continuous basis, so you're not subject to fundraising cycles. And these funds work on a subscription basis, meaning that all the capital is called on day one. Most of the funds, they accept subscriptions on a daily or monthly basis.

The second thing that these funds aim to do is provide a certain liquidity. This liquidity is typically provided quarterly. And as a result of that, investors really have the choice when they want to invest and when they want to get out of their investments. So this is much more flexibility on top. The investment amounts are much lower than in the drawdown fund world. We start at as low as $10,000 USD, and the tax reporting is typically much more efficient, especially for individual investors that would get a 1099 tax form, which is much more handy for their tax statements.

While these products were really targeted towards individual investors in the beginning, we made the experience, particularly within private credit, that a lot of institutions are equally drawn to evergreen funds as long as a couple of criteria are fulfilled, like quality, like content fees and some of the other aspects. And that has been driving major growth in the industry over the last couple of years through BDCs, interval funds, tender offer funds, REITs, in Europe, ELTIFs as an example of these type of fund structures. And the number of these funds has almost doubled between 2019 and 2023, which I think really speaks to the attractiveness of these type of funds for both individual and institutional investors.

Stewart: That's super helpful, Professor For The Day, and I'm just asking questions over here. But one of the key differences that my understanding is that drawdown funds and evergreen funds returns and generate returns in a different way. Can you walk us through how evergreen funds compound gains differently and why that may be an advantage in managing the J-curve? And while you're at it, just for those who may not do this every day, can you tell us what a J-curve is?

Fabian: Sure, sure thing. And you're absolutely right, returns are measured differently between different type of fund structures. I think many investors know what time-weighted or money-weighted returns are through their investments in mutual funds, traditional asset classes, bonds, ETFs, et cetera, et cetera. And evergreen funds can be measured exactly the same way because their cashflow profile is fairly simple. I said earlier you're doing a subscription, all of your capital is called day one, and at certain point in times you may get offered a certain liquidity, which makes the measurement fairly straightforward. Drawdown funds in turn, because of their structure to draw down their capital, mostly measure performance in terms of IRR. And IRR and returns are two different type of shoes. And as a result of that, they are hard to compare.

So when really comparing drawdown funds and evergreen funds, we think that the multiple on committed capital can be used. And this effectively measures on what has been your money that you have earned over the commitment that you have been given. And due to the nature of the evergreen funds, because they ramp very swiftly because they keep a very high investment level, and because of the fact that you can invest ultimately as long as you want, they have significant advantages in terms of multiple on committed capital or MOCC. We actually did a study in that regard and we have been assuming an evergreen fund structure that has a 10% return, including the compounding of the gains, that fund would've resulted in an MOCC of 2.7 times after 10 years. For a drawdown fund to achieve the same multiple uncommitted capital, this drawdown fund would have to achieve an IRR of 17%. And by the way, this assumes that undrawn commitments are invested otherwise, for example, in public equity markets or in money market funds. And as a result of that, we think this is a fair comparison.

If we think about this difference, 10% return, 17% IRR, ultimately leading to the same result, we are talking about a completely different risk profile in the underlying asset class. At least that's what I think. Really hard to provide an outperformance like that if you are investing in the same assets between the evergreen and the drawdown fund.

Stewart: That's super helpful. So just for everybody's information, IRR stands for internal rate of return, which is if you look on your financial calculator, it's on there and that can be calculated, right?

So liquidity and flexibility are often cited as advantages of evergreen funds. I guess the question is how do evergreen funds manage liquidity differently than drawdown funds? And what does it mean for investors in terms of access to their capital? And I'll tell you why this matters so much, is that I've had a number of conversations with CIOs of late and there's not a hard and fast way to determine the liquidity needs of a company. I mean, folks do it different ways, but I think that many of these, and I think it's fair to say that liquidity has a cost, and if you're willing to give up liquidity, you can increase your return significantly. The trick for insurance companies is how much liquidity do I need? So I have a sense that there's risk capacity in some of these insurance companies that could benefit from something like this if they had the feeling, if they had the understanding that they could get their money back out more easily and that it wasn't locked up for 10 years or whatever. So talk us through that.

Fabian: Right, and as you said, these type of investments, they have couple of advantages when it comes to the flexibility. Because you get immediate full and continual capital deployment from evergreen funds, they are fully invested. In contrast to that, the drawdown funds can take years to deploy and may not call all committed capital. Additionally, evergreen funds help investors avoid the reinvestment risk. In drawdown fund structures, you have some recycling of the proceeds from realized investments. Evergreen funds can do that on a continuous basis. Furthermore, evergreen funds provide continually offered flexibility as they offer on a subscription basis, so accepting ongoing investors. Drawdown funds are subject to fundraising cycles, so either a GPS fundraising or it is not fundraising, and as a result of that, the drawdown fund structure may not always be available.

The liquidity option I think is actually the most interesting out of all of this, and we have to remember that the underlying assets are still illiquid assets if we talk about private markets, specifically private equity, private debt, infrastructure, real estate. So how do you solve for liquidity? And I think the first question starts with the assets themselves and how much you offer in terms of liquidity to your investors. I think the beauty about private credit specifically is that the lifetime of the underlying assets, i.e., the loans is fairly short. In a typical private debt portfolio focused on direct lending, you receive around one-third of your portfolio back each and every year. If you're offering, let's say 20% liquidity on an annual basis, your underlying portfolio will provide for a very good amount of this liquidity that you're offering, typically even more in a normal market environment, and around that number in case of a downturn. Also, other asset classes can solve for that through the type of the assets. So for example, in private equity, you can focus more on secondary opportunities, which have a much shorter lifetime than primary deal flow.

The second thing is yes, evergreen funds, they hold certain short-term investments, maybe they also hold cash as part of their overall portfolio construction, and as a result of that, their returns will naturally be slightly lower than the ones of drawdown funds, which are not required to hold those liquidity reserves. In Europe, some of the funds even have a regulatory requirement to hold certain liquidity reserves, and as a result of that, it is inevitable in the overall portfolio construction.

The third point that I'd like to mention is portfolio level leverage. You can lever assets in a portfolio, especially in private credit. It is not uncommon that banks or other capital providers provide a leverage ratio of two to one debt to equity on these type of assets. While this cannot work in the long term, because you cannot just increase leverage to pay liquidity, it's a very nice tool to gap liquidity in the short term, i.e., To bridge certain needs.

And then lastly, it's secondary opportunities. We have seen secondaries becoming more and more prominent in private markets as well. Private credit as an asset class is seeing a real spike in secondary transactions. And as a result of that, secondary transactions not only provide a good way in, but potentially also a good way out of these type of investments. Having said that, and that's my personal view, is if really everything goes south, if we're going to have a type of GFC scenario, or even worse than that, I think that evergreen funds can in theory return to a liquidity profile like a drawdown fund. The beauty of that is the fund will just naturally go into runoff. In a drawdown fund, that may still be in the investment period, and as a result of that, have very little influence.

Stewart: That's super helpful. So one of the things that's front and center on insurance companies' minds is the operations and reporting on their investments. And so it's my understanding that evergreen funds are known for offering more frequent valuations and regular financial statements. Can you talk a little bit about the impact of this transparency on investor confidence compared to traditional drawdown funds?

Fabian: So evergreen funds are mostly done within regulated structure. In the US, the SEC may oversee those funds. In Europe, it's mostly the local regulators that are overseeing these type of structures. And as a result of that, the regulators are setting certain standards. One of them is the reporting frequency and level of detail that you have to go into within your reporting. And these type of reports are very detailed. Every investor can really get portfolio-level details, i.e., position details, typically on a quarterly basis, in some fund structures, even on a monthly basis. And as a result of that, this type of reporting is, in many instances, better than the one of drawdown funds. It is especially much more comparable between the various drawdown structures. Because this reporting is fairly standardized, investors can really compare one report to each other and don't have to look for one number in one report, which may be on page one and in the other report it's on page 10. So much more straightforward to compare.

And then the valuation frequencies for these type of funds are typically more frequent. I've mentioned that evergreen funds are often accepting subscriptions on daily or monthly basis. That also means that valuations have to happen within that cycle. And as a result of that, the level of oversight I think that can be provided by investors can be significantly higher.

Stewart: And so you had mentioned this earlier, but private debt is a popular asset class within the evergreen fund structure. What makes it particularly suitable for this type of vehicle? And how do evergreen funds manage diversification and liquidity in a private debt portfolio?

Fabian: So if you think about the private debt asset class, particularly direct lending, which is the largest sub asset class within private credit, you're talking about senior secured floating rate loans. So these loans, they pay a base rate, they pay a certain spread, and there are also some smaller fees associated with your return. These three components effectively form your return. So outperformance in this asset class is actually really hard on a gross basis because you can only outperform on the spread and on the fees. And typically higher spread or higher fees also means higher risk. So on a gross basis, this is difficult.

Most of the outperformance in Stepstone's views comes actually from diversification, i.e., how large is the diversification within any given portfolio? In order, single idiosyncratic portfolio events cannot influence the overall performance too much. And the second thing is fees, to be honest with you. So it is an asset class that has limited upside potential, and as a result of that, investors have significant opportunity costs not being invested. And evergreen funds, because you invest into them immediately, because they provide the diversification, are addressing a good piece of that.

We also talked about liquidity. I think private debt as an asset class, because of the short lifetime that we have discussed, is just an asset class that has a certain natural liquidity through the repayment profile of the loans themselves. And also when it comes to the repayments, these are much less associated with cyclicality than maybe other asset classes because loans are typically repaid at 100%, i.e., the par value of the loan rather than depending on the overall market cycle, and as a result of that, the asset prices themselves.

Stewart: Thank you. And I guess the last question I've got here is, looking at the insurance space, which is our entire world, what makes evergreen funds appealing for insurers and how should an insurance company determine whether an evergreen fund or a drawdown structure is the right fit for their needs?

Fabian: In the insurance world specifically, I think that both drawdown and evergreen fund structures really have a reason to exist, and certainly for insurance company, the operational aspects with capital calls or the tax reporting is not their primary concern because they have internal operational teams that can handle these type of investments since decades already. Nevertheless, the aspect around the investment, the diversification, the multiple on committed capital is also very relevant for them.

So the question that they need to ask themselves is, can I get through an evergreen fund the same institutional type of quality as I would get into a drawdown fund? Meaning do I get access to the same type of assets that I would get in drawdown funds? Do I pay the same fees as in drawdown funds? And ultimately is the team looking after the drawdown funds the same as for the evergreen funds? And these are very important questions to raise within the due diligence.

So especially on undrawn commitments from drawdown funds, they may elect to invest those in evergreen funds because they get exposure to the asset class very quickly, but they can optimize their returns more through the drawdown fund structures. They don't have that liquidity profile that I've mentioned. They typically outperform in terms of IRR. So they should continue to invest in drawdown structures, but can optimize their portfolio construction through evergreen funds by investing the undrawn amounts into these type of structures.

Private credit as an asset class, on top of that, is an interesting asset class for many insurance companies, irrespective if that's in the US or in Europe under the Solvency II regime. Capital charges are typically fairly low depending on the structure, and in order to make sure that these investments are efficient, comparing the return and the capital that they are required to use for that, you need to look into additional operational aspects such as transparency. The topic here is mostly look-through reporting, position reporting, it is governance and control, and it is lastly the flexibility that these products can provide.

Stewart: That's super helpful. I've gotten a tremendous education from you today on evergreen funds. I know a lot more than I did when you started, and I really appreciate that, and I know our audience does as well. I've got a couple of fun ones for you on the way out the door, if you'll indulge me. We always have very accomplished guests on our show, and we hear from our audience, "How do you get these people," right. I was like, there's some really good people in here. You mentioned getting your undergraduate degree in economics in Munich. When you were coming out of school or if you were to go speak to a class at your undergraduate institution, what advice would you give the senior class that are also finance and economics folks as they move out into this world, given everything that's changed since, I mean, I'm significantly older than you are, but at the end of the day, things have still changed dramatically in the last five years. I mean, just the advent of AI alone is changing the playing field. So what advice would you give someone who's early on?

Fabian: I think from my perspective, having started my career in a very interesting period of time, I'd say the first thing is put your focus on learning, especially me as with an economic background. I did not know a lot about the real business world, about this asset class when I graduated. But because I focused on learning and education, particularly in the beginning, that was tremendously helpful for me later on in my career. And really be broad in that regard, not just focus on one specific asset class, but try to learn as much as possible from on the job experience. I also think, by the way, that the CFA charter is a very interesting way of doing that because it provides a very broad knowledge of the financial markets industry all across from private markets to derivatives to traditional investments, which I think is a great thing to do.

The second thing that I'd mention is stay curious, look into industry developments and ultimately learn through your entire life. Meaning that industries can change, assets can change, and as a result of that, you as a person, you need to remain flexible to adapt to new trends, to learn of what is happening in the market and really adapt and seize opportunities.

Stewart: That's super helpful. I will mention just we are working on curriculum called the Chartered Insurance Asset Manager designation, CIAM, and we're working on that with the institutes, which oversees the CPCU designation. So I'm with you, I think education is super important and we're just trying to fill in some gaps here in the insurance asset management space.

Last one, and a bit of a hypothetical. So you can have lunch or dinner with three guests yourself and three others alive or dead. You don't have to use all three. You can do one, two, or three. Who would you most like to have lunch with or dinner alive or dead?

Fabian: That's a great question. I haven't really thought about that before, but let me pick my brain. I'd say that probably Michael Jordan would be on that table. His career on the court and off the court is really a huge inspiration. What he has done in his sports, he has really pioneered his sport, and as a result of that, I think he would be a great conversation partner in all sorts of things, to be honest with you.

Stewart: I'm a racing fan and he co-owns a team in NASCAR, and they've started to win. And it's super cool to see him out in the winner's circle and hugging his drivers and all that. He's been successful at a lot of what he's done. And so it's interesting. I was never a big NBA fan, but I'm getting a chance to see him in action in racing, which is super cool. Who else?

Fabian: Well, I think when it comes to business, Ray Dalio is certainly one of the guys that really inspired me. I read his book as well, and I think he has a lot of good advice also for younger professionals, obviously. Also, his career has been tremendous, and he has managed to stay on top of the industry over decades, which I think is a great achievement.

Stewart: Is there anybody else?

Fabian: I think let's end it on that note.

Stewart: Yeah, I mean, I was going to say, I mean, I'll join you. I'd be happy to join that table. That's a heck of a table.

Fabian: Stewart, exactly. Please be welcome at that table.

Stewart: That's great. I'd be happy to.

Fabian: That would be great fun.

Stewart: Yeah, that's cool. I really appreciate you taking the time. I think it's super important, super interesting information today on evergreen funds and really appreciate your expertise and knowledge in this space, so thanks so much for being on.

Fabian: Well, thank you. It was a real pleasure having a conversation with you.

Stewart: Thank you. We've been joined today by Fabian Körzendörfer, who's a partner with StepStone's private debt research team. Thanks for listening. If you have ideas for podcasts, please shoot me a note, it's Stewart@InsuranceAUM.com. We are the home of the world's smartest money, and we'll see you next time on the InsuranceAUM.com Podcast.