IPAConnect: Interval Fund Conference Highlights

Introduction

Last week more than 120 asset managers, financial advisors, broker-dealers, fund service partners, and researchers converged on Times Square in New York City, to commence the first-ever industry conference dedicated exclusively to closed-end interval funds and tender offer funds: IPAConnect, hosted by the Institute for Portfolio Alternatives (IPA).

As we covered in greater depth during the week leading up to the event, the IPA’s mission is to expand retail investor access to real assets and alternative investment strategies via a combination of advocacy, education, networking and public relations efforts supporting the “Portfolio Diversifying Investments” industry (PDIs). PDIs include fund structures like lifecycle and net asset value Real Estate Investment Trusts (REITs), business development companies (BDCs), and of course, nearly the sole focus of the event, closed-end interval funds.

At the event, we heard from industry leaders about the growing role for interval funds – with their ability to provide individuals exposure to real assets that preserve capital and generate attractive income – as the nation’s longest-ever bull market presses forward, while spiking inflation far outpaces yields on government-backed securities and investment-grade bonds.

We learned how interval funds’ liquidity restrictions allowed asset managers to invest opportunistically during the COVID-19 pandemic, preventing catastrophic losses while markets panicked, and how interval funds can achieve unique premia through targeted access to private market sectors.

Perhaps most importantly, we also had honest conversations about hurdles the industry needs to overcome before a larger share of registered investment advisers (RIAs) feel comfortable recommending interval fund products to their clients. Luckily, these challenges are surmountable, and some of them even reinforced how important our work here at IntervalFunds.org is to this industry.

In the coming weeks we’ll take deeper dives into these topics and more, with a focus on providing RIAs with actionable knowledge – but you don’t have to wait that long for the highlights.

Here are some of our key takeaways from the first-ever conference on interval funds.

THE GOOD

The Interval Fund Space is Growing and Innovating

Source: SEC.gov (IntervalFunds.org)

Doesn’t matter how you slice it – this has been a banner year for interval funds.

· Total managed assets sit above $57.7b YTD, a nearly 65% increase since the close of 2020.

· There are now 78 active interval funds – the most ever – with one pending deregistration and another 10 funds in pending registration that filed just within this calendar year.

· So far, 18 new interval funds have registered with the SEC this year. While the pace is slightly lagging behind our projection back in April, 2021 is tied for the third-most registrations with more than 6 weeks left in the year.

Looking past the numbers, there are other innovations happening in the space.

· There are two active crypto-related interval funds today. Stone Ridge Trust VI (The NYDIG Bitcoin Strategy Fund), currently in deregistration in anticipation of the adviser launching additional Bitcoin futures funds, and the Arca U.S. Treasury Fund, a treasury bond fund that collateralizes a “stablecoin” traded on a blockchain. Its Net Asset Value (NAV) has been flat since inception, but it’s the first example of an interval fund that can trade shares on the secondary market. Two other crypto-related funds are in various stages of registration as well.

· The Invesco Dynamic Credit Opportunity Fund was the first interval fund to convert from an existing closed-end fund after an exercise in shareholder activism by Saba Capital allowed shareholders to begin tendering shares at or close to NAV after years of trading at a discount.

· Two funds in registration, the Sweater Cashmere Fund and the Fundrise Growth Tech Interval Fund, endeavor to join the Private Shares Fund, the Primark Private Equity Investments Fund (Class II), and the Bow River Capital Evergreen Fund (Class II) in offering investors exposure to private equity, credit and debt investments of pre-IPO companies, regardless of investor accreditation status.

· Alongside a host of credit and real estate products more commonly represented among interval funds, other new thematic funds were registered, including funds focused on social and environmental impact, and a fund that invests exclusively in “longevity-related assets” like senior living facilities.

Notably, this has been a chaotic year for large swaths of the financial sector, in which cryptocurrencies and their related infrastructure, SPACs, funds and companies claiming green/ESG bona fides, capital gains earners, venture capital and private equity – even ETFs and bond traders – have faced degrees of uncertainty related to shifting tax liability and compliance matters.

All of this comes amidst major labor and wage upheaval related to quantitative easing and stimulus payments during the COVID-19 reopening, snowballing inflation and rate uncertainty, dislocated recovery across public and private markets, regulatory shocks overseas, energy scarcity, record-breaking weather and climate disasters across the world, and of course, the infamous Delta variant.

Meanwhile on the interval fund front, things have been relatively quiet, in a good way.

Many interval funds are designed to deliver steady performance with low market correlation, and some – as we’ll get into shortly – are even purpose-built to capitalize on volatility. All interval funds, in addition, are registered under the Investment Company Act of 1940, a relatively uncontroversial statute with investor protects the SEC tends to be comfortable with. So while the SEC is introducing rules 2a-5 and 18f-4 regarding valuations and derivatives, respectively, these rules are viewed as requiring entirely manageable compliance program adjustments and do not create uncertainty for interval funds.

All told, 2021 bodes quite well for the trajectory of the interval fund space.

Interval Fund Liquidity Enables Opportunistic Investing During Selloffs

Let’s look at two real estate-focused interval funds and how they weathered the early weeks of the COVID-19 pandemic.

The Bluerock Total Income+ Real Estate Fund is a nine-year-old interval fund that invests in a portfolio of institutional private real estate funds. The fund passed the $3b AUM mark last month, has delivered about a 17% total return YTD (depending on the share class) with a 5.25% annualized distribution rate. Notably, the fund boasts the highest Sharpe ratio among all domestic ’40 Act funds and has raised 20% of total capital flows into all interval funds YTD.

The Griffin Institutional Access Real Estate Fund is a seven-year-old interval fund that also invests in a portfolio of private real estate funds, though their strategy depends on analyzing publicly observable data rather than Bluerock’s extrapolation models. The fund is the largest real estate-focused interval fund and recently passed the $4.6b AUM mark, has delivered about a 17% total return YTD (depending on the share class) with a 5.22% annualized distribution rate.

Both funds offer retail investors exposure to private real estate strategies for a $1k minimum initial investment, when placed through retirement accounts.

When COVID-19 hit last spring, the Dow Jones US Real Estate Index (DJUSRE), which tracks publicly traded REITs and other companies involved in real estate, lost nearly 43% of its value in 5 weeks, while the S&P plunged over 33% over the period amid a historic sell-off.

DJUSRE. Source: S&P Global

S&P 500. Source: S&P Global

During roughly the same period, Griffin’s interval fund lost just under 8% of NAV, and Bluerock’s interval fund shed just over 2.5% of NAV. Both funds continued paying over a 5% distribution with minimal return of capital.

GCREX. Source: Nasdaq

TIPPX. Source: Nasdaq

(Notice that Nasdaq's habit of clipping their Y-axes exaggerate the interval funds' short-term losses in spring 2020)

How do we explain the roughly 5-17x NAV preservation against the DJUSRE index?

Part of the answer lies in solid due diligence – high-quality borrowers are the “last to crash, first to recover.” Diversification also helps, along with a willingness to accept that markets are going sideways and focus on “what to do now” vs. trying to make sense of why it’s happening.

The most important factor, however, was the quarterly liquidity offered by each interval fund.

Interval funds offer far more liquidity than the 2- to 10-year cash lockup typical of private funds with similar holdings, but quarterly liquidity can be viewed as restrictive relative to the daily liquidity available for securities traded on exchanges. This time, that “restriction” paid off big time for shareholders.

Griffin’s redemption deadlines around the crash were 2/5/20 and 5/6/20. Investors didn’t have the chance to panic sell during the 5 weeks of the crash, and Griffin took the opportunity to remind shareholders of the alpha it delivered alongside its repurchase offer notifications.

Similarly, Bluerock’s redemption deadlines hit on 2/4/20 and 5/5/20.

Compare that to the daily liquidity available in publicly traded REITs and equities, and it’s easy to see why both funds far outperformed the two referenced indices during the crash.

Both funds maintain roughly 20% of assets in more liquid securities, to easily convert to “dry powder” when opportunistic investments present themselves during crashes like these – this largely explains the modest and temporary drop in NAV for both funds. They certainly took advantage of that dry powder and were able to acquire assets at a discount, with Bluerock repositioning a full $1.3b of AUM in 2020.

Neither fund necessarily views COVID-19 as a proper “stress test” akin to the years of stagnation following the Great Recession of 2008, on account of the massive infusion of public money into markets starting in spring 2020, but publicly traded securities benefited from that easing too – and while they were forced to sell, the interval funds took advantage.

It goes to show how interval funds’ quarterly redemptions can act as a stopgap measure against investors’ reactive, knee-jerk psychology during times of sudden volatility. Most interval funds are positioned as long-term investments anyway, so after reflecting on the wins achieved by Bluerock and Griffin, you should ask yourself – are you overestimating your liquidity requirements?

Interval Funds Should Motivate RIAs to Rethink the 60/40 Portfolio Model

These are uncertain times for stocks and bonds.

Thanks to the rapid COVID-19 recovery, the S&P 500 appears to be pressing forward into the longest bull market in history, and despite the third-highest price-to-earnings ratio ever, and increasing numbers of analysts speculating a coming correction due to historical “buy” signals, stocks continue to climb.

The question is, for how long?

At the same time, the S&P 500’s dividend yield of 1.29% is the lowest since August 2000, and one of the lowest since 1960 when yield typically ranged from 3-5%. On the fixed income side of the equation, treasury bonds are yielding below 1.6% on average.

Overshadowing this situation is a 30-year high in US annual inflation, surging to 6.2% in October 2021, with a lack of clarity on whether the Federal Reserve views it as “transient” and the impact on whether it will raise rates. Even Treasury Inflation-Protected Securities (TIPS), which are explicitly designed to hedge inflation, have been so outpaced that the current real 5-year yield sits at negative 2.6%.

This is a big problem for fixed-income investors, who face the prospect of watching their real earnings erode steadily in the coming years, or run the risk of catastrophic loss by allocating to riskier high-yield junk bonds.

Enter interval funds. Thanks to investor protections offered by the 1940 Act, interval funds have the flexibility to invest in a wide range of high-yield alternative assets with low correlation to the stock market, and offer that exposure to non-accredited investors. For example, all 5 of these interval funds pay yields above the current record inflation rate (6.24% to above 11%), all feature low volatility, and all are available to retail investors.

Bain Capital Credit, who executes for the Griffin Institutional Access Credit Fund, and PIMCO, who runs three interval funds including the PIMCO Flexible Credit Income Fund, fully appreciate this advantage.

While markets may be “fully priced” overall, some credit still looks good and performance is dislocated across sectors. Investing directly into private credit markets allows these funds to target sectors like life sciences and inflation-resistant commodities, and achieve historical absolute and relative returns in a yield-hungry environment.

This type of creative investing holds risk, but it also pays off in the form of a “complexity premium.” According to a 2020 Palico study, private equity and venture capital firms in the US have outperformed public equities over the past 5-, 15-, and 25-year periods, and pension funds with a greater than 30% private investment allocation outperformed those with a below 10% allocation by 200 basis points.

Loans may not offer the same transparency as post-securitization bonds invested in similar underlying assets, but if your diligence is solid, it pays to go private.

Luckily with interval funds, anyone can access private markets while benefiting from professional active managers who handle the diligence for you. In a time when stocks are overpriced, yields are down, and inflation is snowballing, interval funds offer a third option that should leave RIAs questioning the classic 60/40 portfolio model.

These validating factors offer just a taste of what we learned at IPAConnect, and covering everything will (obviously) run too long for a single article – hence our upcoming series. Before we wrap today, however, we want to address some of the challenges still facing the industry.

THE OPPORTUNITY

Interval funds are still a nascent space, despite suggestions that they could eclipse traditional closed-end funds within the decade. The reasons for that speculation are credible.

With a new industry comes new challenges, and while interval funds have enjoyed a drama-free regulatory experience thanks to their ’40 Act protections, there are persistent issues with education, process, and technology that have limited their growth to date.

Overcoming these challenges is possible, and there are plenty of success stories available – just look at the growth of ETFs in the last decade. It’s exciting because groups that solve these issues early are likely to enjoy outsized performance in the space.

Education Needs to Happen, Immediately

The alternative investment industry is worth about $10 trillion in total assets and offers a powerful alternative to the 60/40 portfolio model, as we covered earlier. The problem is, RIAs aren’t taking advantage.

For example, in 2018 MLG capital reported that 93% of RIAs have clients asking them about real estate on a regular basis, but less than a third respond with allocations to private real estate markets. Most stuck with publicly traded REITs, which – as demonstrated above – underperform relative to private markets when things get volatile.

According to PPB capital partners, only 20% of RIAs leverage the interval fund structure in any capacity, and while high net worth private investors allocate 40% or more of their assets to alternatives, 55% of advisors don’t allocate anything to alternatives at all – and the average allocation is below 5%.

A 5% allocation doesn’t move the needle on deriving the benefits from an interval fund.

There is clearly a gap, given that 57% of RIAs are focused on downside protection, and 55% on portfolio diversification – two primary benefits offered by interval funds – and the main hurdle is a lack of education that limits awareness and leads RIAs to overestimate alternative risks.

That education vacuum is literally what motivated us to launch IntervalFunds.org. When you have a rapidly growing category that offers access to retail investors, and your only options are stale/incomplete fund databases, overcoming an $800/year paywall, or slogging through the Edgar database on a piecemeal basis, you have a problem. Instead, we slog through Edgar for you, and we don't monetize this website.

Everyone from Blackstone to B of A Merrill Lynch to Morgan Stanley appreciates the education imperative, and have prioritized advisor education as the biggest challenge facing the industry. It’s a large reason why IntervalFunds.org was welcomed into the IPA community.

The sooner we win on education, the sooner more RIAs will feel comfortable recommending alternatives, and that benefits everyone – particularly retirees and pensioners who don’t want to be forced to choose between taking on more risk or seeing their fixed income eroded by inflation.

Process and Technology are Necessarily Improving

For RIAs that do allocate to private illiquid funds, a full 95% described them as between moderately difficult and highly challenging to administer. Part of the issue was valuation challenges, and another part was concerns about net expense ratios – both factors that interval funds can overcome with proper education and fund design.

However, another chief complaint about allocating to alternatives is difficulty of use and sub-docs. In an era where FinTech is changing the investment landscape, asking a client to fill out 100 pages of subscription documents and the like makes these recommendations untenable for many advisors.

We’ve experienced this problem firsthand and happen to hold strong SEO rankings for a certain large interval fund that doesn’t have its own fund website. When quarterly redemptions hit, we field questions from RIAs trying to figure out how to redeem client shares, who are dismayed to conclude an arduous information search by learning they must ask fund-approved broker-dealers to mail in paper docs on their behalf. That's rough.

The situation is improving, however, with more interval funds providing up-to-date NAV and performance data online and providing for digital fund subscriptions. We would be shocked if the industry didn’t move toward providing mobile access to retail clients in the coming months.

Distribution is also improving, with platforms like CAIS and iCapital Network providing digital solutions tailored to alternatives, and faster-moving traditional platforms like TDAmeritrade hustling to catch up. So far, Schwab and Morningstar just blog about it.

With the opportunity inherent in interval funds, we doubt these challenges will present hurdles for much longer – and here at IntervalFunds.org we’re committed to doing our part. 

Expect a dedicated focus on RIA-facing education from our content and research team until further notice.

CONCLUSION

The conference was validating for both IntervalFunds.org and the interval fund space more broadly, whether you hear it from managers of some of the best interval funds in each sector, or other industry players who are growing their careers with these products.

The fund structure offers clear advantages outside of the typical stocks/bonds mix, and despite a stellar year for interval funds, we are convinced this is only a taste of the growth to come.

Thank you again to the Institute for Portfolio Alternatives for welcoming us into this community.

Research request? Send us a note at alpha@intervalfunds.org, or just DM us at @interval_funds.

Note: This article is for information purposes only, and does not constitute an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or any other product or service referenced herein. 100% of the information presented in this article is supported by publicly available research.