Interval Funds

Sep 09. 10:53

Why Interval Funds are Growing in Popularity

Industry Developments towards Illiquid Assets

Interval funds have been around for more than two decades, but investors started taking notice of them over this past year. What changed?

The answer goes back to the 2008 Financial Crisis. Since then, there has been increasing demand by investors to pursue alternative investments, and the steady recovery of the market also brought increased regulatory oversight and public scrutiny for the financial industry.[1] This combination of regulatory changes and greater interest in diversification has shifted the financial world’s attention toward this overlooked investment vehicle.

The Changing Regulatory Environment

In 2017, the US Treasury Report made recommendations to the SEC on creating clearer guidelines for holding illiquid assets.[2] These recommendations were intended to promote investments in smaller companies whose shares might have limited or no liquidity. As these rules might push certain asset classes to be less liquid, asset managers are forced to use alternative structures to pursue these assets.

At the same time, active asset managers are still facing fee pressures from the ’08 Crisis. A recent U.S. Fund Fee study shows that fees hit an all-time low, with fees dropping by half over the past 20 years.[3] Closed-end interval funds offer a wide variety of fee structures, including, in some cases, higher fees than a mutual fund.

Also, President Trump signed the “Economic Growth, Regulatory Relief, and Consumer Protection Act” in 2018. This act recommended that the SEC change its existing rules on all closed-end funds. In response, the SEC proposed new rules that provided closed-end funds greater flexibility like qualifying for Well-Known Seasoned Issuer status with automatic shelf registration.[4] These new rules dramatically reduce the regulatory obstacles of all closed-end funds, including interval funds, and are scheduled to take effect in May of 2020.

The changing liquidity rules, increasing fee pressures, and new SEC rules have shifted the industry perspective on interval funds. When they were first formed, interval funds were unappealing because of their regulatory hurdles. But the changing financial environment has shifted the balance. Not only has the SEC reduced their legal and regulatory obstacles, but the remaining requirements on interval funds also work to promote transparency to investors. Now, the potential gains from interval funds far outweigh the regulatory costs.

Regaining Consumer Trust

Another major factor for the rise of interval funds is the importance of transparency. The Financial Crisis dramatically increased consumer distrust of the financial world. The 2019 Edelman survey reported that financial services are still the least-trusted industry out of all sectors, ranking below the fossil fuel industry.[5] And even though trust is rising in all sectors in the United States, only 58% of the population trusts the finance industry. Even in the industry itself, asset management ranks lower than insurance and credit cards.

Interval funds help solve the problem of transparency. Unlike other alternative investment vehicles, such as hedge funds, interval funds are registered with the SEC and comply with their transparency regulations, such as providing annual financial reports to their shareholders. As current market trends favor transparency, interval funds are an appealing option for asset managers to rebuild their trust with investors.

Furthermore, interval funds offer very low minimums for investors. UMB reports that over 70% of investment minimums are less than or equal to $10,000, with many being as low as $1,000.[6] Depending on its fee structure, some interval funds may even opt to have no minimum requirement at all. This low minimum – alongside the unlimited cap on the number of investors – make interval funds appealing to both managers and investors.

Another great feature of interval funds is the periodic repurchase offers. As they only offer liquidity through periodic redemption offers, interval funds do not need to have a daily liquidity ratio. That means investors cannot pull their money out whenever they want, there are specific time periods and procedures they must follow. This allows the asset managers to give investors access to institutional-level investment opportunities that were only available to elite institutions in the past. By giving retail investors greater opportunities to diversify their portfolio, interval funds help increase the trust between the industry and the public.

Interval funds help resolve many of the current trust issues between investors and managers. In the current financial climate that emphasizes transparency alongside returns, interval funds create a clear outline on how a manager can achieve both.

The Best Investment Product on the Market?

The previous negatives of interval funds are now positive attributes in the current finance climate. As a result of the ’08 Crisis, the financial industry is still facing pressures on fees and lack of transparency. The regulations on interval funds are now positive qualities, as they improve transparency for shareholders without compromising on returns. So long as the current trends lead to greater transparency and illiquidity, interval funds will gain greater significance within the industry.

Interval funds provide investors and asset managers with the best of both worlds. Interval funds are like mutual funds because they offer continuous purchases, yet they have constraints on constant liquidity for daily redemptions. They offer investors greater access to investment opportunities through illiquid strategies, yet they are also protected from the volatility of other closed-end funds as they do not trade at a discount or premium to their NAV. Interval funds have the strengths of both open-end mutual funds and closed-end funds, but none of the drawbacks.


Photo by Edward Howell on Unsplash