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Interval funds: the cash back option

Some of private debt’s largest players have found a way to offer retail investors limited liquidity through a traditionally illiquid credit platform. 

Interval funds – hybrids between hedge funds and closed-end debt funds which repurchase investor shares at regular intervals – are in vogue in the private credit world.

The US Securities and Exchange Commission has declared effective 38 active interval funds, which have amassed $16.12 billion in net assets between them as of 8 August, according to data collected by Interval Fund Tracker.

The main difference between these hybrid funds and a typical debt fund is that the interval fund manager periodically buys back investors’ shares, which cannot be traded on a secondary market. Interval fund managers must allow investors the option to purchase 5-20 percent of the fund’s equity at select intervals, usually quarterly or semi-annually, and they are required by law to price these shares at net asset value allowing investors more liquidity than your run-of-the-mill long-term debt fund.

The $16 billion in capital these funds currently have at their disposal may pale in comparison with amounts raised by traditional debt funds, given that the latter have collected $61.6 billion in the first six months of 2017 alone, according to Private Debt Investor data. But nine interval funds launched last year alone, compared with none in 2015, despite the fact the structure has been around since the early 1990s. Moreover, 18 interval funds had registrations filed with the SEC waiting approval as of August – including some of private credit’s biggest players like Blackstone GSO’s Floating Rate Enhanced Income Fund.

But fund managers providing liquidity every quarter with a balance sheet stocked with illiquid investments makes things complicated. In February, a Morningstar analyst warned that “given the potential illiquidity of their underlying holdings, high fees and the complexity associated with the redemption process, interval funds should probably be thought of as niche investments, if they’re thought of at all”.

But several firms that launched interval funds recently tell us that the unique share buy-back structure is popular because some non-institutional investors need such a feature to access alternative credit. These investors may not be able to access traditional, long-term closed-ended funds, either due to the return profiles or the locked-up capital structure.

Brook Taube, chief executive of Medley, which launched an interval credit fund last November, says the Sierra Total Return Fund was designed to provide retail investors with access to private credit, while offering an appropriate amount of liquidity.

“Access to private credit can help satisfy investors’ demand for yield,” Taube adds. “The fact that the [interval] fund offers liquidity on a quarterly basis makes it an attractive structure for retail investors.” 

Like all the interval fund managers PDI spoke to, Medley has opted to buy back 5 percent liquidity of the Sierra fund on a quarterly basis. The fund invests in debt and equity securities, primarily focused on US and floating rate assets, while it is targeting a $1 billion fundraise and 7-8 percent returns.

CION Investment Group teamed up with Ares to launch an interval credit fund last year. Michael Reisner, co-chairman and co-chief executive at CION, agrees with Taube that these funds allow retail investors access to new assets traditionally only available to institutional investors.

“With the redemption features, the interval funds are perfect for investment managers, which have traditionally focused on illiquid investments, to bring their products out to retail investors in a ’40 Act wrapper,” Reisner says, referring to the US Investment Company Act of 1940, which all interval funds have to register under, as do business development companies.