Legal Lingo: Liquid or Illiquid? Open or Closed? Navigating Fund Structures

Being an aspiring commercial lawyer often means being confronted by complex, often abstract, concepts leading to an often impenetrable wall of jargon for students and trainees. Next up in our Legal Lingo series, which we've introduced to help break down this jargon, is an explanation of different investment fund structures.

Investment funds allow multiple investors to pool their money into a professionally managed portfolio, offering diversification and access to a wide range of assets. These funds act as financial intermediaries, channelling capital into various investments. Two key structural components that influence how a fund operates are whether it is open-ended or closed-ended, and its degree of liquidity.

Illiquid, Closed-Ended Funds

Illiquid closed-ended funds are the predominant structure for private market investing. These funds raise a fixed amount of capital during the fundraising period, close to new investors, and have a fixed term of around ten years, with possible extensions of one to two years, in which to invest, earn and distribute capital.

Investors, commonly institutional or professional, are locked in to commit capital upfront. This capital is drawn down over time as needed and returns are distributed to investors as assets of the fund are sold, generally toward the end of the fund’s life. Investors typically cannot redeem their investments during the term of the fund, with transfers generally occurring through secondary market sales to other investors.

Liquid, Open-Ended Funds

Open-ended funds permit investors to enter or exit at regular intervals, usually determined by the fund’s net asset value (NAV). Typically utilised in liquid markets, open-ended funds allow assets to be bought or sold to meet redemption requests.

Liquid, open-ended funds are less common in private markets because private assets cannot be quickly liquidated. To address this, managers may allocate a portion of the capital to liquid investments and must maintain high levels of cash or implement mechanisms such as redemption gates to control outflows and meet liquidity needs, which can negatively impact performance.

Exchange-traded funds, which are available to all investors, are a common example of liquid, open-ended funds. These funds do not have a termination date, allowing investors the flexibility to buy or sell their shares at regular intervals, with transactions priced at the fund’s NAV.

Evergreen Funds

Hybrid fund structures, such as Evergreen funds, address the shortcomings of traditional private equity funds by combining elements of both open-end and closed-end funds to meet investor needs. Evergreen funds pool capital from multiple investors to invest in a diversified portfolio of private companies, similar to closed-end funds.

The key difference is that Evergreen funds are open-ended, continuously accepting new investor commitments with a perpetual fundraising duration. This allows existing investors to redeem their shares for liquidity or rebalance their portfolio more frequently. This offers asset managers an alternative to traditional fundraising cycles.

Evergreen funds also broaden their appeal to a wider investor audience, including retail investors, by eliminating the extended lock-up periods typical of closed-end structures. However, bringing private capital strategies to retail investors comes with unique challenges, such as varying investment patterns, increased liquidity expectations, and stricter regulatory requirements.

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