Mutual funds are a great way for investors to gain exposure to many different stocks, bonds and other asset classes in a single, diversified portfolio that is run by a professional money manager. Mutual funds are considered open-ended funds because, according to the Investment Company Act of 1940, these funds can continuously issue more and more shares to the public.
An interval fund is a combination of an open-ended fund and a closed-end fund that allows investors access to various asset classes that open-ended funds are generally restricted from purchasing. As of the first quarter of 2018, interval funds have been growing in popularity with assets over $21 billion, up 58% from the year before. The Versus Capital Real Assets Fund LLC is one of the fastest growing interval funds in the marketplace, with over $393 million in net assets under management. The Versus Capital Real Assets Fund will be used as the primary example throughout this article.
To familiarize yourself with regulations governing the mutual fund industry, read about the Investment Company Act of 1940.
Interval funds offer daily investments but only a stated portion of the fund’s shares are available for sale or redemption during predetermined intervals. The Versus Capital Real Assets Fund offers sales and redemptions on a quarterly basis, with no less than 5% and to a maximum of 25% of the outstanding shares. Similar to Versus Capital, many other interval funds offer sales and redemptions on a quarterly basis, making it much more illiquid when compared to open-ended funds that allow sales and redemptions on a daily basis. Some interval funds are even more illiquid, with the sale and redemption period available only on a bi-annual or annual basis.
However, even though both open-ended funds and interval funds have different sales and redemption periods, both are regulated under the Investment Company Act of 1940.
Click here to learn about how mutual funds are different from Unit Investment Trusts (UITs).
Open-ended funds also only allow a maximum of 15% of illiquid investments within the portfolio. Interval funds have a maximum of 95%, with 5% needed to maintain liquidity minimums. This allows the fund to hold these private securities without the regulation of the typical open-ended fund that is required to have at least 85% of the fund liquid. For example, the Versus Capital Real Assets Fund has $80 million in a private investment fund called the RMS Evergreen U.S. Forestland Fund LP. Mutual funds would not be able to invest this much into a relatively illiquid investment without surpassing the 15% threshold.
In contrast, while interval fund fees vary depending on the fund, management fees are usually in excess of 1.5%, with service fees of up to 0.25% and more than 3.5% in annual fees. The Versus Capital Real Assets Fund has an investment management fee of 1.15%, other expenses of 0.30%, and acquired fund fees and expenses of 0.15%. The fund has total annual fund expenses of 1.60%. If the interval fund has institutional investment funds within its holdings, then the fees can range from 1.00% to 1.50%. In the case of the Versus Capital Real Assets Fund, the prospectus states that it allows a maximum of 50% in these holdings, which would be a maximum total of 0.70%, leading to total annual fund expenses of 2.30%.
On top of that, redemption fees of up to 2% of repurchase proceeds are typically charged by interval funds to help the fund pay for expenses related to periodic repurchases.
Interval funds, on the other hand, have a higher level of risk, due to the illiquidity of the fund. If an investor panics and wants to pull their investment out of an interval fund, they cannot redeem their shares until the next interval period. Also, due to the structure of interval funds and their ability to invest in as much as 95% illiquid investments, a fund’s underlying holdings might be unsuitable for some investors. Many interval funds require their investors to be accredited. To be an accredited investor, a person must demonstrate an annual income of $200,000, or $300,000 for joint income, for the last two years with the expectation of earning the same or higher income. Also, individuals with a net worth of at least $1 million would qualify as an accredited investor.
The Bottom Line
An interval fund’s biggest risk is its relatively illiquid nature, as it only offers redemption opportunities on a quarterly, bi-annual or sometimes annual basis. Its fees and investment structure should also be researched to ensure that the investment is suitable in nature. However, if an investor can withstand the illiquidity and risk level, interval funds should give some upside and uncorrelated returns to their overall portfolio.
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