An interval fund is a type of closed-end fund with shares that do not trade on the secondary market. Instead the fund periodically offers to buy back a percentage of outstanding shares at net asset value (NAV).
The rules for interval funds, along with the types of assets held, make this investment largely illiquid compared with other funds. High yields are the main reason investors are attracted to interval funds. Here is a closer look at these investments.
Buying Is Easy But Expensive
Interval fund shares are usually offered for sale daily by the fund at the current net asset value. Depending on the fund and its guidelines, shares may be restricted to accredited investors but most interval funds are available to anyone.
Limited Selling Opportunities
By rule, interval funds periodically offer to repurchase shares of the fund at the stated NAV. The repurchase period can be every 3, 6 or 12 months. Most funds offer to repurchase quarterly.
The repurchase announcement will specify a date by which you must accept the repurchase offer and the percentage of all outstanding shares the fund will buy – usually 5% and sometimes up to 25%. Since repurchase is done on a pro rata basis, there is no guarantee you can redeem the number of shares you want during a given redemption.
Because of these restricted selling opportunities, an interval fund should be considered a long-term, mostly illiquid investment. (See 4 Benefits of Holding Stocks for the Long Term.)
Yields Are High...
The ability to invest in alternative types of assets, such as commercial real estate, consumer loans, debt and other illiquids, also helps increase interval fund yields.
...And So Are Fees
Overall fees for interval funds tend to be much higher than those for open-end mutual funds. One fund starts with a 5.75% sales charge, has a management fee of up to 2.45%, a 0.25% servicing fee and as much as 0.75% in operating expenses.
Not counting the sales charge, annual expenses for this fund could be as much as 3.45%. Annual returns can and do exceed fees, but investors need to know that the bar is often high.
The New Commercial Real Estate Funds
One alternative investment class recently made available through interval funds, commercial real estate, deserves special mention. As opposed to REITs, which invest in property pools and trade like stocks, interval funds invest directly in the properties themselves.
While the return on commercial real estate (6.93%, the National Council of Real Estate Investment Fiduciaries reports) has been almost identical to the return on the S&P 500 stock index ( 6.95%), interval funds are less volatile than REITs, which are subject to the trading whims of the market. That’s partly because real estate based interval funds rely more on steady rental income than on capital appreciation.
Pros and Cons of Interval Funds
In deciding whether these investments belong in your portfolio, you may want to consider this list of pros and cons.
- Returns on interval funds are significantly higher than those of open-end mutual funds.
- The illiquid, long-term structure of interval funds helps restrict normal investor “buy high/sell low” behavior.
- Interval funds provide retail investors with access to institutional-grade alternative investments with relatively low minimums.
- Funds often less volatile and market reactive since investments are not tied to equities.
- Interval funds are essentially illiquid, especially compared to open-end mutual funds.
- Since repurchase is done on a pro rata basis, there is no guarantee you can redeem all of your shares during a redemption window.
- Although yields are higher, so are fees – much more so than with open-end mutual funds.
- The minimum investment, which is low by private equity standards, is still high when compared to the minimum for open-end mutual funds.
- There is both a transparency and conflict-of-interest issue if the portfolio manager is allowed to invest in other funds of the fund sponsor.
The Bottom Line
The main advantage of interval funds is that they offer yields that are higher than most other mutual fund options. The two main disadvantages are higher fees and illiquidity. As noted above, illiquidity can be a positive if it forces you to keep an investment long term.
Before investing in an interval fund you should consider what portion of your portfolio could tolerate the long-term commitment required for this type of vehicle. You should also carefully research any interval funds that interest you to make sure the fees are not likely to eat up any yield advantage.
Finally, you should consult with a trusted financial advisor to make sure you have not overlooked potential traps and that an interval fund makes sense for you.