The Practice of Evergreen Funds in China

Evergreen funds offer certain advantages over typical private equity funds. However, their extended investment horizon requires investors to place a high degree of trust in the fund sponsor and possess significant confidence in their management capabilities. In the Renminbi (RMB) market, regulatory restrictions have limited the adoption of the evergreen model. Although examples such as Hui Capital’s 2021 blind pool evergreen fund (which raised approximately RMB1.2 billion) exist, they remain relatively rare.

Evergreen funds commonly have a duration set at more than 20 years, with options for sponsor-led extensions or even no end date. Nonetheless, private equity funds in China must adhere to the requirements of the Asset Management Association of China (AMAC), a body authorised by the China Securities Regulatory Commission to oversee private funds in China. This includes the necessity of a fixed duration, and any extension beyond the typical 8–15 years requires a reasonable explanation. Therefore, RMB evergreen funds generally need to operate under a hybrid model, combining a fixed duration with the possibility of extensions under specific circumstances.

Although evergreen funds offer a longer operational life compared to traditional private equity funds, they often incorporate certain redemption mechanisms to cater to investor liquidity needs. However, these funds may still implement restrictions to manage potential redemption pressure and maintain their long-term investment goals. These restrictions include setting a lock-up period in the fund’s early stages to ensure stability, setting minimum Net Asset Value (NAV) requirements for redemptions to align investor interests with fund performance, and capping the amount any individual investor can redeem at once to prevent excessive capital outflows.

It is important to note that the AMAC mandates that all private equity funds are to operate as “closed-end” structures. This means actions such as increasing or decreasing commitments and exiting the fund are restricted to specific pre-defined situations throughout the fund’s lifetime. Consequently, these regulations further limit the available liquidity mechanisms for RMB evergreen funds.

Evergreen funds typically calculate management fees based on the NAV of the fund, although some may initially charge fees based on the fund size. The NAV method provides a more accurate reflection of the sponsors’ management value and, to some extent, serves as an incentive for their improved performance. Additionally, some evergreen funds may implement further management fee adjustment mechanisms – for example, management fee claw-back for the fund to reclaim previously paid fees if the NAV of the fund falls below a certain threshold or setting a maximum amount that can be charged as management fees (regardless of the NAV).

The method for distributing performance-related profits to sponsors can vary significantly, based on factors such as investor type and fund performance. Nevertheless, it is common to design performance profit distribution based on the asset value at the end of a specific performance cycle, such as the open redemption period. This may involve paying a performance fee to the sponsor if the NAV reaches a certain threshold or if it outperforms specific benchmarks.

On 30 March 2018, the AMAC introduced the “Guidelines for the Valuation of Unlisted Equity Investment of Privately Offered Investment Funds (for Trial Implementation)” to guide the valuation of unlisted equity by Chinese private investment funds. While the primary purpose of valuing typical private equity funds is to inform investors about portfolio companies, their current operational status, expected returns, and potential risks, this does not directly affect sponsor or investor earnings.

However, this valuation plays a more significant role in evergreen funds where both management fees and performance fees are tied to the fund’s NAV. Sponsors in these funds must therefore carefully consider valuation methods and frequency to maintain investor confidence. Furthermore, investor subscriptions and redemptions are directly linked to the fund’s valuation – thus highlighting the importance of a robust valuation system tailored to different objectives and market conditions, staffed by professionals, and regularly verified.

In China, launching and running a successful evergreen fund relies heavily on sponsors finding investors who embrace the model and its long-term investment horizon. This is particularly challenging given the current market, which is dominated by traditional private equity funds, with investors familiar and trusting of their operating and economic models. Notably, Fund of Funds (FOF) investors – often subject to shorter investment terms – are generally unsuitable for the evergreen model.

Therefore, beyond navigating regulatory hurdles and technical complexities, sponsors of evergreen funds must seek investors who prioritise value creation and long-term returns. This alignment is crucial for sponsors to balance capital stability with maximising investor returns throughout the fund’s lifespan.