The History of Interval Funds – and Where They’re Heading

Late ‘80s Resurgence for Closed-end Funds

In the late 1980s, there was a resurgence of closed-end funds. In 1986, there were only 69 closed-end funds with $12 billion assets under management (AUM). This number grew to 290 funds with almost $73 billion AUM by 1991.[1] This resurgence in popularity drew the attention of the SEC, and led to the implementation of better rules to allow the growth of closed-end funds by solving the issue of closed-end volatility.

During this time, closed-end funds were experiencing a problem in volatility after their initial public offerings. Most closed-end funds had their shares trade at a discount to its net asset value on the stock exchange.[2] The SEC believes this was a result of low commissions on secondary trades. As a result, most closed-end funds lost significant value during the first 120 trading days after their initial public offering. This started a trend where seasoned investors would wait after the IPO to buy shares at a discount.

In response, fund managers started to develop closed-end funds that continuously offered their shares. These tender offer funds were possible due to Section 23(c)(2) of the 1940 Investment Act that allows closed-end funds to purchase their own shares through tender offers.[3] So these funds found a way of continuously offer shares to the public through discretionary tender offers to their shareholders. Furthermore, tender offer funds would trade their shares at NAV, rather than a discount, avoiding the volatility that came along with traditional closed-end funds.

The Birth of Interval Funds

Recognizing the public demand for better rules, the SEC made interval funds possible through Rule 23c-3 of the 1940 Act. In its 1992 report Protecting Investors: Half Century of Investment Company Regulation, the SEC made recommendations to create rules that guided closed-end firms on repurchase offers at set intervals.[4] A year later, Rule 23c-3 passed and established the procedure of repurchase offers on a quarterly, semiannual, or annual basis. Thus, the “interval fund” was born.

Though they were established in the ‘90s, this unique fund structure was sidelined in the finance world. During this time, the US economy boomed with a series of changes to political, economic, and financial regulations. In 1993, not only did the Clinton Administration agree to join, they also created a surplus in the national budget by cutting government spending. This restrained long-term interest rates, which boosted financial investments in the domestic market.[5]

At the same time, new innovations in the open-end fund space drew public attention away from interval funds. The rise of exchange-traded funds (ETFs) became incredibly popular with investors for their low management fees. Plus, in a decade when the stock market almost tripled, it became a no-brainer for investors to focus on traditional investments like stocks. By capitalizing on the seemingly unstoppable growth of the stock market at the time, ETFs started to dominate the financial world. Though it was a great time for investors, the ‘90s economic boom also pushed interval funds away from public attention for almost twenty years.

Tailwinds for Interval Funds

Things started to change after the 2008 Financial Crisis. At first, the Financial Crisis saw the total assets of closed-end funds drop by almost half between 2007-2008.[6] However, since the slow recovery of the market, there have been trends that have shifted the finance industry towards closed-end funds once again. Investors started to demand more diversification within their portfolios to minimize potential losses during market crashes. As a result, many fund managers started to look for alternative investment strategies that are not correlated to the market.

Alongside investor demand for diversification, legislative and regulatory changes have also shifted the attention of asset managers. The 2012 Jumpstart Our Business Startups (JOBS) Act decreased SEC regulations on advertising securities offerings, thus encouraging more investment into private equity. Then the 2017 US Treasury Report encouraged the SEC to create rules that would allow for even greater investment into private companies by registered funds. Finally, the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act also directed the SEC to decrease the regulatory burden of all closed-end funds. All of these legislative and regulatory changes created a shift in the finance industry that will encourage investment managers to look into alternative asset classes, such as private equity, while also allowing registered funds easier access to these investments.

Since then, interval funds have been taking over the closed-end space. Between 2014-2018, interval funds have grown at an annual rate of 42.9%.[7] Asset managers are starting to realize the potential of this overlooked investment vehicle as a response to new trends after the ’08 Crisis. While the number of tender-offer funds have decreased, the number of unique interval funds has increased from 27 to 66 between 2015 and 2018. Although it took some time, interval funds have begun to surge in popularity since their creation in the 90s.

Interval funds will only grow more prominent in the future. They offer the optimal balance between liquidity for shareholders and flexibility for managers to pursue illiquid assets. As these funds are not required to follow the same liquidity requirements as open-end funds, fund managers have greater opportunities to invest in high-yielding illiquid assets. At the same time, they have set rules to help protect the investor with a structured repurchase offer. In a new financial world built after the ’08 Crisis, demand for non-correlated investments will become a staple for investors who wish to minimize their losses during a recession. To access these investments, interval funds are the best option. 

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