Interval funds have been the talk of the private wealth business for several years, as retail investors seek to access alternative asset classes to diversify their portfolios. Among the private wealth professionals who have devoted a lot of their attention to interval funds and the role they play for the individual investor is Kimberly Flynn, managing director of alternative investments at XA Investments.
How are interval funds distinguished from mutual funds?
Interval funds are a type of U.S. registered closed-end fund built to house illiquid alternative assets. In contrast to private funds which typically house alternatives, interval funds offer investors a number of protections and conveniences commonly associated with mutual funds, such as low minimums, 1099s and board oversight. Interval funds share several mutual fund features, including a continuous offering of shares and periodic redemption of shares directly by the fund. To facilitate alternatives, interval funds do not permit daily redemptions but instead offer quarterly redemptions through a tender offer. As such, interval fund investors must consider the appropriate time horizon for alternatives, which is longer than for mutual funds. Interval funds have higher fees in line with higher expected returns than mutual funds.
Why are interval funds increasing in popularity?
Given the challenges of traditional investing today — near peak equity market valuations while bond yields remain anchored near record lows — interval funds are rising in popularity as investors seek to diversify their portfolios. The appeal of interval funds is driven by increasing investor demand for private and uncorrelated assets. In contrast to the largely disappointing liquid alt mutual fund trend in the 2010-2015 period, interval fund adoption is expected to continue growing in future years because the product structure is a better fit for illiquid alternatives, such as private equity where retail investors have limited access.
How should investors evaluate interval funds and potential client portfolio fit?
To properly assess an interval fund, one must consider the portfolio manager’s experience and ability to meet the fund’s objectives. Since the interval fund market is relatively young, most funds have short track records, usually less than three years. Therefore, the assessment of the management team and their experience with similar strategies is critical. A growing crop of interval funds is income-oriented and pays attractive levels of current cash flows. When investing with a long-term horizon, it can be helpful to receive distributions while patiently waiting for higher levels of total return over time.
Investors should also evaluate an interval fund’s overall asset mix to determine if the fund has sufficient liquidity to pay distributions and meet quarterly tenders. Interval fund sponsors should not oversell the liquidity features of the fund. While the interval fund structure helps restrict the buy high/sell low panicked behavior of investors, those same investors do not like being gated. Interval funds are an attractive addition to the portfolio for investors with longer investment horizons, higher risk tolerance and fewer liquidity needs.
What types of interval funds are available in the market today?
Interval funds include a wide array of alternative strategies, including both public and private investments. Credit and real estate funds hold the top two positions as the most popular categories based on net assets. Credit funds include a variety of strategies such as directly originated loans, corporate bonds, asset-backed securities, commercial real estate loans, government and municipal obligations, convertible and preferred securities, derivatives, and others. Equity, including hedge fund strategies, holds third place, followed by insurance-linked securities. The interval market has expanded in recent years to include a number of private equity-focused funds. Expect to see more of a focus on sustainable funds and venture capital in the coming year.
How do you see the interval fund market evolving over the next five years?
While the interval fund market has grown quickly, the evolution of the systems and operations to support the market have not. Emerging fintech managers and fund administrators are leading the way to automate certain aspects of interval fund operations, including the front-end subscription process and the back-end tender offer process for liquidity. The asset management industry revolves around the infrastructure set up in the 1980s to support the mutual fund market and 401(k) platforms. In the next five years, because of these anticipated technology and operational advancements, expect to see the widespread adoption and use of interval funds by financial advisers and their clients.