The Growth and Appeal of “Semi-liquid” Funds

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Advisor Perspectives
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One of the trends in financial innovation over the past decade has been interval and tender-offer funds. While first allowed as investment products over 25 years ago, they have risen in popularity to provide greater access to illiquid, long-term investments that were previously limited to private funds. A wider opportunity set of investors and historical alpha generation has attracted asset allocators and strategy providers and positioned interval funds and tender funds as a key solution.

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Raising capital has always been a critical activity for the growth of a thriving business. Apart from raising a small portion of capital from friends and family and relying on excruciatingly expensive bank loans, businesses used to dream and plan for an IPO and raising debt from a public exchange. However, over the past decades, the growth of private capital has opened new sources of financing. Private market AUM grew to almost $10 trillion dollars as of H1 2021.1 More than $1 trillion in institutional private capital has been raised per year globally across all asset classes.2

The reason for this phenomenon is simple: Public companies represent a small and shrinking part of the universe of successful enterprises and historical returns have been inferior to private offerings. There were 7,810 public companies at the beginning of 2000 in the U.S., and that number shrank to around 4,800 by the end of 2022. Investable private companies have continued to grow. In the U.S., there were only 2,600 public companies with annual revenues of more than $100 million in 2021, compared to around 17,000 private corporations of that revenue magnitude.3

The appeal of private markets is not just the sheer size of the opportunity, but the fact that institutional funds have consistently delivered alpha over the years across all asset classes. The Cambridge Associates LLC US Private Equity Index, which compiles returns from over 1400 PE funds formed since 1986, shows a net alpha generation to limited partners of more than of 470 basis points over both 20- and 25-year horizons relative to both the Russell 2000 and the Russell 3000 indices under a modified public-market-equivalent calculation.4 What is even more alluring is the consistency of outperformance. Private equity and private credit have outperformed global public markets equivalents in 21 of the last 22 years.

Economists have studied the reasons for outperformance of private offerings. Longer execution and strategic time horizons, multiple exit value creation options, higher control of operations, and the ability to attract stronger entrepreneur-oriented managers are some of the reasons that are often given for the outperformance of private equity. In private credit, stronger contract management (more rigid lender protection clauses and use of covenants), faster and easier execution, and significantly higher flexibility for capital solutions are often cited as the reasons for superiority of private debt over public market paper.

As much as private offerings seem to be a raw diamond for asset allocators, these products were narrow in reach and limited to sophisticated institutional investors with large minimum investments. They had no redemption or early exit possibility prior to the development of the still-thin secondary market. Why have interval funds and tender offer funds become such a popular way to access private offerings? The answer rests in three simple components: liquidity, transparency, and the feasibility of wider non-institutional access.

Tender funds and interval funds are extremely similar. Tender offer funds have more flexibility in when they offer to buy back shares and have fewer options for offering new share classes. Interval funds, as alluded by the name, make periodic purchase offers on a predefined (interval) schedule and based on the net asset value (NAV) in compliance with SEC Rule 23c-3 under the 1940s act. In simple terms, investors are allowed to redeem their investment on a quarterly, semi-annual, or annual basis. The frequency of repurchases varies by fund and is determined by the fund offering policies. Funds usually limit the repurchase offer to 5% of the fund’s NAV per quarter to avoid forced asset liquidation events.

Another extremely appealing attribute of interval funds is their frequent purchasing intervals. Most funds allow for monthly or quarterly purchases at NAV, and usually without a queue. Although interval and tender offer funds are technically closed-end funds, they often amend registration to increase shares. It is impossible to underestimate the importance of liquidity and the ability to participate in the product throughout time.

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