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Retail growth for interval funds on the horizon

By Angele Paris – There is a growing interest in offering unlisted, interval and tender-offer closed-end funds to retail investors, providing them access to alternative, potentially higher yielding strategies. To realise this growth, the industry needs to support and educate registered investment advisors (RIAs) about these products who will in turn increase their clients’ knowledge and understanding.

“Everything is set up to see the marketplace for these funds really grow,” says Terry Gallagher (pictured), Executive Vice President, Director of Fund Accounting & Administration at UMB Fund Services. “We expect to see increased flows as RIAs get more comfortable with such funds, understand their usefulness and see the demand on sales platforms. I believe we’re in a good place to have the market continue to build for some time,” he says.

Interval funds have grown at an annual rate of 42.9 per cent since 2014 to end 2018 with USD27.2 billion in assets according to a recent report produced by FUSE Research Network and UMB Fund Services. And the benefits they provide investors suggest they will continue their upward trajectory.

The persistent low yield environment and market uncertainty have pushed investors and their financial advisors to turn to alternatives in their hunt for return. Interval funds offer access to higher yielding alternative investment strategies within a structure which still allows for some liquidity.

Interval funds are valued daily but the liquidity they offer is limited. This restricted liquidity is the main aspect of such investments that retail investors need to come to terms with, Gallagher explains. “It’s a growing marketplace and there’s still a lot of education involved. Part of the education deals with the less liquid nature of some holdings in these closed-end funds. Redemptions are only offered on a periodic basis, usually quarterly, so some of the education involves the issue of liquidity . It’s about getting the RIAs to work with individual investors and help them to get comfortable with the idea that its ok to have a portion of an investment portfolio in these less liquid investments,” he says.

As long as an investor’s portfolio has enough liquidity built into it to meet any cash flow or emergent needs, then it may make sense to have a small portion allocated to assets with less liquidity. This, according to Gallagher is a key element in the learning curve which will help to see the growth in interval funds come to fruition.

The second challenge to further growth within the interval funds market is around the specific investment strategies interval funds employ. Retail investors are likely to be less familiar with investments like private credit or direct lending and therefore the RIAs’ role is vital in educating their client-base and improving their knowledge in this regard.

In addition to providing the potential for greater yield, interval funds also offer investors the opportunity for returns, uncorrelated to the general markets, while adding an element of diversification. Gallagher says, “many of these strategies offer non-correlated returns; They don’t move with the regular marketplace. One of the things we learned after the 2008 crisis was every  sector can take a hit. So investors  may consider getting some of their portfolios out of that mix to allow them to handle the volatility of the general market a little bit better.”

Gallagher says that one of the most attractive asset classes for interval funds is currently private credit. “We are seeing strategies focusing on less liquid debt. This tends to be higher yielding and a little bit more illiquid due to being more connected to the source of the loans,” he says.

He lists primary credit, real estate investments and direct lending as well as other strategies which go directly to the source of financing as some of the most prolific parts of the interval fund market, at the moment.

The regulatory environment can also provide a boon to seeing additional growth in interval funds. Recently, the SEC issued proposals to simplify the registration process of such funds. The regulator is questioning how to make the process easier and fee payments simpler. Gallagher explains: “One of the drags on the growth is that interval funds take a little bit longer to get to market because the registration process is more cumbersome. Registering a mutual fund is fairly straightforward and can usually be accomplished in a shorter period of time compared to a closed-end fund. This means that not only is the registration process longer, but it can be more costly due to the new organisations boards being set up, registration fees etc.”

Therefore, having the SEC supporting a process which is more straightforward and does not involve additional cost will help to increase the penetration and deepen the distribution of these closed-end interval funds.



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