What You Need to Know About Interval Funds

By Jimmy Pickert, CFA®, CFP®, CRPS®

Jimmy Pickert, CFA®, CFP®, CRPS®

Jimmy Pickert, CFA, CRPS® Portfolio Manager

The investment industry is constantly evolving to bring investors unique ways of enhancing their portfolios. One of the more exciting evolutions in recent years is the advent of vehicles called interval funds. This blog will introduce you to the concept of interval funds as well as the benefits and drawbacks.

At first glance, interval funds look identical to mutual funds. Just like mutual funds, they contain a basket of securities that are maintained by a professional fund manager. They’re also similar in that they don’t change in price throughout the day like stocks and exchange traded funds do—interval funds update their price once daily, typically after the stock market closes. And just like mutual funds, interval funds are designed with a certain investment theme in mind. For example, an interval fund may focus on real estate or a certain segment of the bond market.

For the most part, the similarities end there. Unlike mutual funds, which you can sell at any time to receive your money the next business day, interval funds can only be sold at certain intervals, typically every three months. Interval funds also limit how many shares can be sold in a given quarter. For example, it’s common for an interval fund to limit the number of shares sold to 5% of the fund’s existing shares. Some interval funds also limit when you can buy them, too, though this is less common. This liquidity restriction is the primary drawback of interval funds, but what you get in return is often worth the tradeoff.

In a traditional mutual fund the fund managers are required to keep the portfolio full of securities that can be sold with short notice in case a large number of the mutual fund investors decide to sell their shares. Interval fund managers, however, enjoy much broader investment opportunities because they can operate with the confidence that they won’t be forced into selling any of the underlying securities for long periods of time, and even then, not more than 5% of their portfolio. This allows interval funds to invest in securities that offer great diversification and return potential to your average investor.

Interval funds offer investors access to opportunities that used to be reserved only for hedge funds and institutions. Private real estate offerings, infrastructure investments, lesser known corners of the bond market and even securities that are tied to natural disaster reinsurance are just a handful of the themes that are now available in an interval fund format. Not only do interval funds offer more liquidity than most hedge funds, but their availability is not limited to high new worth accredited investors, either—a common hurdle in the hedge fund world. Incorporating interval funds into a traditional stock and bond portfolio can help diversify your sources of return and risk in ways that weren’t possible before.

I have already described the main disadvantage of interval funds as the liquidity restriction. We expect that for most investors, a three-month lock-up is a price worth paying in exchange for the unique investment opportunities; after all, investing usually involves a time horizon of several years anyway, so the short-term liquidity restriction has little impact on the typical investor. Still, you should limit your exposure to interval funds to a minority stake of your overall portfolio in case you have an unexpected need for cash. Exactly how much is appropriate for you will depend on your comfort level.

Another consideration before investing in interval funds is that they tend to have higher fees than traditional mutual funds. This is due both to the specialized nature of the underlying investment strategies and the fact that these funds don’t face the same competitive pressures of the much more crowded traditional stock and bond mutual fund industry. While fees are important to consider before any investment decision, it’s important to focus on net-of-fee performance and, especially in the case of interval funds, the diversification benefit to your overall portfolio before ruling an investment out based on fees alone.

Finally, make sure you understand the strategy and process of an interval fund before you decide to invest. Despite the benefits discussed above, these funds still can and will lose money from time to time just like more common types of investments. Because these vehicles are used to invest “off the beaten path,” researching an interval fund will require more due diligence effort to understand the risk and return potential than would a plain vanilla large cap stock mutual fund.

Used appropriately, interval funds may be an extremely valuable addition to your portfolio. With the current bull market in stocks growing older and all-time low interest rates suppressing the yields on bonds, now is a great time to consider whether interval funds should be included in your portfolio. Contact us today if you would like to learn more.

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— Topics: Investments, Wealth Management, interval funds