Interval funds are closed-end fund structures that may periodically offer to redeem shares from shareholders.1
What is an interval fund?
An interval fund is an alternative investment vehicle legally classified as a closed-end fund and regulated under the Investment Company Act of 1940, as well as the Securities Act of 1933 and the Securities Exchange Act of 1934.1 Interval funds are generally illiquid investment products that periodically offer opportunities for limited liquidity by repurchasing a stated portion of its shares from shareholders.
Interval funds differ from typical closed-end funds in several ways. Like open-end funds, they may continuously or periodically offer new shares, but, as their name implies, they redeem only a limited number of shares periodically throughout the year in predetermined intervals of usually three, six, or 12 months.2
Interval funds offer repurchases, which depending upon the fund could be between 5% and 25% of fund assets.3 They are usually not traded on an exchange, and shareholders generally submit repurchase requests to sell a portion of their shares back to the fund.
Interval funds’ limited redemption windows allow them to invest in illiquid or less liquid assets for which no secondary market is readily available. They can hold up to 95% of their portfolio in illiquid assets, as opposed to only 15% for open-end funds.4 In addition, interval fund portfolio managers may have greater latitude in developing and maintaining complex and/or long-term investment strategies without concerns about meeting the needs of daily redemptions.
The fund manager can directly distribute interval funds or the funds can be sold through financial intermediaries and broker-dealers. If an interval fund’s shares are not registered under the Securities Act of 1933, they can only be offered to accredited investors.5 If they are registered, the shares may be offered more broadly to retail investors.6
Some interval funds offer relatively lower investment minimums when compared to other private market commitments.7
What investments make up an interval fund?
Interval funds can provide an opportunity to invest (indirectly) in assets historically accessible to institutional and accredited investors. The underlying investments of these funds may be comprised of highly illiquid, potentially higher-yielding assets—for example, private real estate, private equity, private debt, derivatives, infrastructure, or hedge funds.8 Interval funds are usually centered on a particular investment strategy.
Since an interval fund generally cannot readily sell the assets in its portfolio—at least not at their fair market value—the fund may have to borrow or sell other assets to meet its cash obligations or pursue its strategy. However, the fund’s leverage cannot exceed more than 33% of its gross asset value.9 The portfolio’s illiquidity may also affect the market price of those investments, potentially impacting the fund’s net asset value (NAV) and its ability to pay dividends. In addition to liquidity risk, investors incur risks based on the particular investment strategies the fund’s managers pursue.
How do interval funds work?
As noted, interval fund investors generally cannot sell (or buy) the shares of interval funds on public exchanges. Instead, the funds will seek to offer a limited percentage of their outstanding shares for redemption at the fund’s NAV only at certain periods of the year, usually quarterly, semiannually, or annually.10
The repurchase offer deadline will fall between 21 and 42 days from the date of the notice establishing the redemption period.11 Shareholders can typically make or modify their repurchase requests at any time up to, but not after, the deadline. If shareholders miss the redemption deadline, they will have to wait until the next redemption period to sell their shares. In addition, depending on the percentage of outstanding shares made available and the number of redemption requests, investors may only have part of their request fulfilled. Conversely, shareholders are under no obligation to sell any of their shares during any redemption period.
What are the costs and risks associated with interval funds?
Because of their active management and illiquid asset structure, interval funds may provide potential opportunities for higher returns than other fund types; however, financial advisors should be aware that the associated costs and fees could impact net performance.12 13 Interval funds’ management fees and expenses tend to be significantly higher than those of open-end funds.14 In addition, interval funds can charge a “repurchase fee” from the sale proceeds, compensating the funds for their repurchase expenses. This fee cannot exceed 2% of the repurchase proceeds. 15 Unless an interval fund restricts its investor base to qualified clients only, interval funds typically do not charge incentive fees like other private funds.
When researching interval fund costs, advisors should also note the distinction between a fund's distribution rate and its returns. The distribution rate for some funds will also include a return of principal, which should not be mistaken as income or capital gains from the fund.
Interval funds may be subject to the same risks associated with their underlying investments, such as volatility, business risk, credit risk, interest rate risk, and others. Advisors are strongly encouraged to read the fund prospectus before making any investment decision.
