Alternative fund managers who wish to avoid the limitations of running ’40 Act mutual funds, and the risks that come with having to constantly provide daily liquidity, are turning their attention to closed-end interval funds. UMB Fund Services has a decade of experience providing turnkey solutions for managers looking for an elegant route to market.
Although not a new product innovation, interval funds and registered hedge funds offer fund managers the ability to control redemptions and deliver returns that allow illiquidity premia to be more fully realised. The only difference between the two is that the former has a daily NAV while the latter has a monthly NAV. And whereas alternative mutual funds are limited to only holding 15 per cent illiquid securities and must offer daily liquidity, interval funds have a quarterly or less frequent redemption period.
UMB Fund Services has long had exposure to these registered closed-end continuously offered products. Its Registered Fund Solutions platform provides a complete solution for those wishing to establish a registered hedge fund in as simple and straightforward a manner as possible.
“Our first experience with one of these products was back in 2007,” says Tony Fischer (pictured), President of UMB Fund Services. “The client had great success and we thought there was no reason why, if an investor is looking to diversify their portfolio with an illiquidity premium, they should not have some exposure to interval funds. It’s a great way to get into the illiquid market yet still enjoy the kind of transparency that you get with a mutual fund product.”
Over the years, UMB Fund Services has made significant investments in its technology and getting the word out to the market that it is an expert in structuring these products and can help managers, both from an operational and strategic perspective.
“We’ve built a solid book of business for these structures. We’ve established ourselves in the investor record-keeping space as a top provider,” says Fischer.
The popularity of this sub-set of active funds has ebbed and flowed, becoming particularly popular following the global financial crisis when investors suffered liquidity traumas and wanted access to products that could still offer a decent return but without the risk of getting locked in to a fund for years. Closed-end registered hedge funds were seen by some as the ideal solution.
“When the market started picking up five years ago, people went back to favouring traditional long-only funds, ETFs gained a lot of traction and this was the start of passive investments becoming popular. In 2014, 2015 and 2016 we saw all kinds of variations of ETF products, some hybrid, some smart beta, but mostly based on customised indices,” says Fischer.
As these are passive products, however, some investors are again starting to realise that they need an active component in their portfolios. At the one end, traditional mutual funds and ETFs and at the other end, exposure to more complex, illiquid closed-end products.
Their popularity is evidenced by the fact that PIMCO and other high-profile investment managers have launched interval funds in recent months. Recently, Morningstar reported that as of February 2017 there were about 30 interval funds in existence, accounting for a total of around USD 9 billion in assets, plus another 20 in registration.
“As active money continues to move to passive, RIAs are telling investors that they still need some exposure to active strategies. They still need to take a bit of added risk, but traditional offshore hedge funds are, in my view, dark pools; you don’t fully know what is going on inside them. Interval funds and registered hedge funds offer access to illiquidity premia while also offering more transparency and regulatory oversight,” explains Fischer, adding:
“With an interval fund, although it is limited to tender between 5 per cent and 25 per cent of its shares for any given period, it does give investors a daily NAV and the chance to buy shares every day.”
Given that these funds tend to operate in more illiquid areas of credit (high-yield bonds, distressed credit), as well as private equity and real estate, the NAV is based on price estimates. Still, the fact that they are registered funds means that investors can easily find out their composition, should they need to, on a quarterly basis.
Education is key, says Fischer, for interval funds to continue their upward trajectory.
“There are many managers who need to be educated, who don’t necessarily know the limitations of these products and they need to be able to explain the proposition clearly and precisely if they launch a fund. Some of the platforms still need to be educated on these products, and investors as well. This is starting but it takes a while for a new idea – even one based on a product that has been around a long time – to take hold.”
The turnkey solution that UMB Fund Services offers is especially useful to smaller managers who do not have the resources of a PIMCO or Blackstone to launch one of these products under their own resources.
Just as series trusts are turnkey solutions for managers wishing to get into the mutual fund business, Fischer says that the interval fund turnkey solution provides the full infrastructure to handle administration, accounting, audit, legal counsel, chief compliance officer, as well as a board of directors to provide oversight.
“We’ve serviced these structures since 2007 and we’ve seen all types of products come to market. One of the benefits to working with us is that not only do we make it efficient and cost-effective to operate an interval fund, we bring to bear 10 years’ of experience working with these structures in different market environments,” confirms Fischer.
In his view, there is no clear need for the manager to spin out of the turnkey and operate the fund on a standalone one or two years down the line, “Unless you absolutely want to have your own board of directors. You’re not going to enjoy the economies of scale with a standalone fund as you would with a platform arrangement where you share the cost with others.
“At the end of the day, we embrace complexity and we are set up to handle just about any structure. This commitment is crucial to helping our clients grow their business.”
