When someone starts tracking a new investment vehicle, it’s usually because the category is catching on and no one else is tracking it. That’s what spurred Jacob Mohs to create the Interval Fund Tracker this year. The Interval Fund space is still relatively small, with only $17 billion in assets under management as of the third quarter of 2017, but Jacob was intrigued. “It’s an interesting space that’s accelerating, and I saw a gap that other data providers were not filling,” Jacob told my colleague.
Don’t be surprised if you’ve never heard of an interval fund or its “sibling,” the tender-offer fund. They both belong to the family of so-called unlisted closed-end funds, and while they’ve been around since 1993, unlisted closed-end funds have not made much of a splash until recently.
Their growing popularity can be traced to the never-ending search for higher and uncorrelated returns. But it can also be tied to tapping the so-called “mass affluent” retail market and arguably, to academic work by the behavioral economist and recent Nobel Laureate Richard Thaler who argues that we aren’t rational consumers, after all.
In 1992, the SEC published a landmark study recommending the industry to “chart new territory between the two extremes of the open-end and closed-end forms of investment funds.” In other words, explore the possibilities that lie between highly liquid mutual funds and illiquid closed-end funds.
Interval and tender-offer funds were created to meet that challenge. Unlike traditional closed-end funds, interval and tender-offer funds do not currently trade on the secondary market. Instead, interval funds offer to repurchase 5-25% of their shares at net asset value at certain intervals — it could be every three, six, or 12 months. Tender-offer funds also offer to repurchase shares, but at times set by the fund’s trustees.
This “not too hot, not too cold” liquidity feature was designed to appeal to investors who aren’t super wealthy and want access to potentially higher returns that illiquid investments can deliver without the long lock-ups, capital calls, K-1 tax forms or the high minimums typically required by alternative investments. About two-thirds of interval funds have an investment minimum of $10,000 or less, while about half of tender-offer funds have $50,000 or lower minimums, according to an industry report.
What strategies do interval and tender offer funds pursue? They fill their portfolios with the both predictable and the innovative. Some specialize in private equity, others in marketplace lending, where consumers and businesses connect with investors who want to buy or invest in loans. Other funds buy catastrophe bonds tied to insurance companies, real estate, credit, and long/short equity. Or you can invest in multi-asset funds that combine strategies under one umbrella.
Obviously, limited liquidity helps managers who are trying to implement these strategies. Portfolio managers can invest without fear of investors rushing to the exits if markets head south. At the other end of the spectrum, these funds may be doing investors a favor by being less liquid than open-end funds.
Being able to convert any asset into cash immediately and easily sounds like a perfect world for investors, but studies show that’s not the case. Individual investors are often their own worst enemy, according to Dalbar, the Boston-based firm that evaluates the financial services industry.
“No matter what the state of the mutual fund industry, boom or bust, investment results are more dependent on investor behavior than on fund performance,” Dalbar states in its 2017 report. “Mutual fund investors who hold on to their investments are more successful than those who try to time the market.”
Those findings probably would not surprise behavioral economists like Thaler. The relative illiquidity of interval and tender-offer funds could potentially benefit investors two ways — by providing access to the illiquidity premium that may be reflected in higher-yielding securities, while protecting against a rush for the exits at precisely the wrong time.