The investment industry continually adjusts to meet the demands of investors – to be sure, at a price. One of the newer vehicles that demonstrates this point is the interval fund. Interval funds have been around for more than 20 years, but because of the increased interest in alternative assets they have gained in popularity. At the end of June, total assets amounted to $23.3 billion, up 48% compared to last year.
These funds straddle the space between closed end and open end mutual funds, and also the space between private investments and mutual funds. Interval funds are SEC registered, closed-end funds that engage in continuous offerings of their securities. Because they do not offer daily liquidity, they are classified as closed end; however, the continuous offering of shares differentiates them from exchange traded closed end funds that have an initial public offering.
In general NAV is priced daily, but redemption of shares only occurs periodically, at certain intervals – hence the name. The interval may be monthly, quarterly, or yearly, and the frequency is disclosed in the fund’s prospectus.
Interval funds are registered with the SEC under the 1940 Act, like other mutual funds. Unlike open end mutual funds, interval funds are not restricted to holding only 15% of the assets in illiquid investments. The only liquidity requirement is that the fund must maintain enough liquidity to meet redemption requests. As a result, these funds can hold private equity, real estate, structured debt, and other illiquid alternatives generally limited to private placements. Like mutual funds, investors do not have to be accredited or qualified and the minimum investment is usually much lower than a private placement. Therefore, these funds are democratizing illiquid assets and allowing more people to invest. Consequently, individual investors have more opportunity to invest in assets that have lower correlation to the movement of stocks or bonds. And because these funds are registered under the 1940 Act, investor protections, such as frequent NAV calculations, restrictions on the use of leverage, and improved governance, oversight is enhanced versus private investments. Another benefit over private placements for many investors is that tax reporting is through a 1099, not a K1, simplifying tax preparation.
While they offer individuals greater opportunity to invest in assets that are not correlated to the public markets, there are caveats of which investors should be aware. Besides the reduced liquidity when compared to mutual funds, management fees are generally higher. The typical expense ratio for an actively managed mutual fund is about 1.5%, but an interval fund’s expense ratio can be as high as 3%. In addition, an interval funds may deduct a repurchase fee of up to 2% of the proceeds to cover expenses related to the repurchase.
So investors have to understand the costs before investing. And since interval funds have differing objectives, they do not move in tandem. Therefore, investors have to understand the fund’s objectives before investing in order to ensure they get the exposure they desire. Although these funds may not be for everyone, they continue to expand the opportunities available to individual investors.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Washington Trust Bank.