Jun 29. 06:16
Deregistering Interval Funds
Interval funds may focus on long-term investing, but they don't always operate perpetually.
2021 is on track to smash the record for new interval fund registrations, but what happens when an interval fund closes for business?
In this article we explain how to deregister an interval fund, and crunch the numbers on the 24 interval funds that have – or in one case, should have – officially called it a day.
INTERVAL FUND DEREGISTRATION BASICS
All interval funds are registered under the Investment Company Act of 1940, as amended (the "40 Act") and must observe a set of rules that offer better transparency and accountability to shareholders than typical unlisted private funds (check out our Learn page for a refresher).
However, each fund is unique, with its own unique set of risks, and the law provides some flexibility in how an interval fund elects to cease operations.
Why shut down an interval fund?
Deregistering a fund isn't necessarily an indication that something has gone awry; an interval fund's board, adviser and sometimes shareholders themselves may elect to shut a fund down even if it has achieved its investment objective.
Perhaps a more attractive opportunity has emerged, or a fund determines its shareholders would be better served with different liquidity requirements. Other funds may prefer to avoid the reporting required of publicly listed funds, or in (thankfully) rare cases, things just haven't worked out as expected.
Are there different ways to deregister an interval fund?
Liquidation: the fund is returning assets to existing shareholders and ceasing to exist as an investment management company.
Merger: the fund is merging with at least one other fund, and likely providing shareholders with shares of the new fund. Usually, but not always, the surviving fund will not operate as an interval fund.
Abandonment of Registration: the fund is not effective, or has not issued any shares, and has opted not to pursue registration as an interval fund after all.
Election of status as a Business Development Company: the fund is requesting approval to operate as a Business Development Company ("BDC") rather than a closed-end interval fund. This can also be achieved with a merger.
How does the deregistration process work?
Beyond the type of deregistration selected on the Form N-8F, an interval fund seeking to close up shop first needs to answer a number of questions:
· Should outstanding shares be distributed pro rata to shareholders?
· Should share distribution be calculated based on net assets in the fund?
· If liquidating, can distributions be made to shareholders in kind?
· What about special considerations for any senior security holders?
· How should the fund handle any remaining assets, outstanding debts, or other liabilities?
· What about any existing litigation, administrative proceedings, or ongoing business activities unrelated to winding up the fund?
· How should the fund allocate money for deregistration costs (attorneys, accounting, filing), and who covers the bill?
· What specific requirements are laid out in the fund's articles of incorporation and bylaws?
Once the fund has these answers, they need to file any applicable merger or reorganization agreements, then take action to formalize the decision. Depending on the fund's bylaws, this could look like a board of trustee vote, a shareholder hearing and/or vote, or simply a determination by the adviser.
Finally, the fund completes and files Form N-8F with the SEC, and receives an N-8F order confirming the end of its days as a closed-end interval fund.
WHERE ARE THEY NOW?
Photo by DANIST on Unsplash.
Of the 24 registered interval funds that are no longer (or were never) in operation, 12 opted for liquidation and 7 went through mergers. 2 abandoned their registrations and none directly applied to become BDCs.
3 others stopped filing annual and/or semiannual shareholder reports without filing N-8Fs, which is a bit inconclusive, but we know exactly what happened to one of them.
Liquidations – 12 Funds
Average time from effective date to the final N-8F filing: 1.89 years
Despite being the most popular form of deregistration, most liquidations aren't particularly noteworthy. In most cases a fund's board of trustees would elect to terminate the fund, with shareholder approval if required, and distribute assets to shareholders.
In the case of the UBS Enso Fund, the investment adviser made the call to liquidate unanimously. Interestingly, the CLA Strategic Allocation Fund operated for a few months in 2015 and seemingly abruptly liquidated the fund as soon as it began to outperform the S&P 500 Total Return Index.
Mergers – 7 Funds
Average time from effective date to the final N-8F filing: 4.64 years
5 out of 7 mergers resulted in surviving funds that offered daily redemptions, exchanging the outstanding interval fund shares with equivalently valued shares of the new fund. Notably, funds that went through mergers tended to operate for much longer durations than funds involved in any other type of deregistration.
While no deregistered interval funds converted directly to a BDC, the Pathway Capital Opportunity Fund merged with Triton Pacific Investment Corporation, Inc. (TPIC) with both board and shareholder approval, and changed its name to the Prospect Flexible Income Fund, Inc. (FLEX) which operates as a BDC.
The only interval fund that deregistered and emerged as another interval fund was the Resource Real Estate Diversified Income Fund, which was merged into the Goldman Sachs Real Estate Diversified Income Fund upon shareholder approval.
Abandonment of Registration – 2 Funds
One of these funds backed out of the registration process before its effective date. The other, the Sierra Total Return Fund, strangely filed to abandon their registration 4 years after their effective date, with over $2.5m in assets under management. While the fund's shareholders voted to approve the abandonment, the fund's N-8F filing did not state how the fund's assets were distributed.
No N-8F on file – 3 Funds
2 of these funds appear to be unremarkable, and it's possible their N-8Fs were simply not posted to the SEC's Edgar database upon dissolution.
The GL Beyond Income Fund (GBFLX), however, was extremely remarkable and may ring a bell for anyone who's been following the interval fund space since its esoteric days.
The GL Beyond Income Fund did not file an N-8F and is technically still operating, albeit as somewhat of a zombie. In the spring of 2015 MarketWatch reported that Daniel Thibeault, founder of the adviser GL Capital Partners, LLC and co-portfolio manager for the fund, was arrested for fraud – specifically, using fund capital to issue fictitious loans. Out on $700,000 bail, he would immediately face a civil suit by the SEC for misappropriating roughly $16m of fund capital.
He then violated his bail terms by starting another financial services company, but the bail was quickly reinstated to the shocked objection of the fund's trustees. The trustees, who reportedly each had at least $1m of their own capital in the fund, penned a letter to shareholders expressing a belief that Thibeault "remains a potential menace" before one trustee finally resigned.
We won't speculate why GBFLX didn't cut its losses and officially deregister, but it didn't, and shareholders are left to wait for scheduled repurchase events to access their funds – presumably while collecting income from the non-fraudulent loans acquired by the fund as they winnow down the fund's AUM on a quarterly basis.
Ouch. The less-liquid nature of interval funds is supposed to be an advantage for investors who don't require daily liquidity, and want to see a larger share of their capital allocated to illiquid assets with strong yields.
Interval funds deregister on occasion, and we are glad that GBFLX is a significant outlier. A deregistration typically means increased liquidity for shareholders.
Still, anybody considering investing in an interval fund should carefully read the fund's prospectus and statement of additional information – including sections on the fund's proxy voting policies and procedures, and control persons – to make sure they are comfortable with the risks of investing.