As the market continues to scrutinize evergreen funds amid a heave wave of redemptions, particularly for private credit BDCs and interval funds; Morningstar has unveiled new analysis assessing the overlap in holdings between different evergreen funds.
In addition, the report examined how cash allocations (sometimes as much as 15% of a fund’s AUM), which help funds meet redemption requests, also cut into overall returns. When combined with the high relative fees for semiliquid funds, it creates a high hurdle to clear that investors should keep in mind when considering allocating to the funds.
In terms of overlap in holdings, the report found that over a third of the direct lending Morningstar category’s assets sit in companies held by five or more unique funds. On average, private credit funds share about 20% of their borrowers with peers.
“A lot of these products are sold as exclusive portfolios where private asset managers tout their sourcing ability and unique access to deals that others don’t have,” said Jack Shannon, principal, equity strategies, for Morningstar and the author of the research. “Part of the motivation of the research was to test that. … You find that they have some of the same amount of overlap. It’s certainly not a commoditized space, but it might be less unique than people probably realize.”
On the private equity side, where tender often funds are often structured as fund-of-funds, there is less overlap than with semiliquid private credit products, but Morningstar found issuers still rely heavily on brokers and secondaries, making them less distinct.
Shannon also noted that the analysis sheds light on the differences between firms that can originate deals for their funds and asset managers that operate solely as aggregators.
“There is potential for an originator to create value by driving the terms in a way that non-originators can’t,” Shannon said.
In terms of cash allocations, Shannon added that advisors and investors should factor that into how that can potentially erode yields.
“You already have higher fees compared with public equity returns, and then if 15% of the portfolio is not earning equity returns, that’s an additional hurdle,” he said. “If you are paying a premium price, you should be getting a premium. … A 300 basis point fee becomes effectively even higher, relative to what’s invested. … If you want to invest in one of these to beat public markets, you have to understand with high fees and high cash allocations, it creates a high hurdle to clear.”
The report also looked at concentration within portfolios. The top five industry group exposures in semiliquid funds account for about 55% of total assets, compared to just over 40% in the S&P 500.
It also found that about 27% of allocations are to software companies. That’s considerably higher than the 6% allocation in the S&P 500, although in line with the roughly 25% weight in the Morningstar LSTA US Leveraged Loan 100 Index.
“This gets to how they are sold. They are sold as diversifiers,” Shannon said. “But if people are worried about the tech weighting in public markets and want to reallocate out of public equity, if you got into semiliquid funds, you are still going to get a lot of tech. If you are trying to avoid reduce tech risk, you are not accomplishing that with these.”
The report also found private credit portfolios typically have weighted average maturities of four to five years, though relatively few loans are set to mature by 2028. That’s important because some of the liquidity generated comes both from maturing loans and prepayments.
“You talk to these managers and they say, ‘The loan has a seven-year maturity, but a four-year life.’” Shannon said. “But on the software side, if you are banking on them prepaying at the same levels as they used to, that might be a little challenged. Who is buying or IPOing software companies right now? It’s not the best time.”