Pimco introduced one in February, followed by FS Investments in March, and 20 more are in registration, which is equal to two-thirds of their current universe, according to Morningstar. They’re interval funds, similar but very different from closed-end funds, and if you haven’t heard of them you might want to learn about them if for no other reason than their growing presence among alternative investments.
In addition, the recent launches from Pimco and FS Investments focus on generating income in the current low-income market, which is a growing goal for many advisor clients.
A key characteristic of interval funds is their illiquidity. Shares are unlisted, they have no secondary market and can be redeemed only during certain intervals, hence the name, and not all at once. Those intervals are typically quarterly, often after a specific lockup period. Redemptions are usually limited to between 5% and 25% of one’s assets and can be drawn out over weeks.
These restrictions help fund managers take a longer term approach and avoid fire sales of assets at cheap prices during times of sudden, massive redemptions, which can help boost returns.
In the case of FS Investments’ new Energy Total Return Fund (XFEYX), this long-term investment horizon provides “opportunities to invest in natural resource companies with a higher total return potential than the opportunities available to those funds managing to daily liquidity,” according to its prospectus. The fund can invest in debt and equity securities of public and private energy and energy infrastructure companies.
“The energy industry has great long-term fundamentals if you have the flexibility to invest selectively across the entire sector and capital structure,” explained Chairman and CEO Michael C. Forman in a statement.
But “investors should be compensated through higher returns for less liquidity [known as the liquidity premium] and more risk,” said Marc Yaklofsky, senior vice president, corporate development, at FS Investments.
The "primary reason to own interval funds," according to Morningstar analysts Cara Esser and Brian Moriarty, is "to gain access to these illiquid markets and earn a high payout.” Those markets include catastrophe bonds, hedge funds, real estate securities and small-business loans.
Other reasons to own interval funds include their relative benefits compared to closed-end funds and hedge funds.
Unlike closed-end funds, their shares are available for purchase on a continuous basis and at a price equal to their net asset value, not at a premium or discount to NAV, and unlike hedge funds they can be available to less wealthy, unaccredited investors.
Forefront Income Trust (BFITX), for example, provides unaccredited investors access to high-yielding lending opportunities (loans to small- and medium-sized business), which are are often restricted to accredited investors in hedge funds.
“Everyone is trying to get out of hedge funds, trying to find the next alternative investment,” said Cole Reifler, president of Forefront Capital.
But like many alternative investments, interval funds are expensive. They charge high management fees — ranging from 0.50% to 2% — and high gross expense ratios, ranging from 1.5% to 5%, according to Morningstar. Some funds also charge front-end loads, which can range as high as 5.75% for A shares.
“Investors considering interval funds should pay careful attention to overall fees (including front-end loads, brokerage fees, redemption fees as well as annual management fees) and fully understand the redemption process and policies,” the Morningstar analysts wrote.
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