Any conversation about public and private market convergence soon turns to semiliquid funds, which come in a few flavors, each limiting investors to periodic, and often capped, withdrawals.
Semiliquid funds owe their moniker to this limitation on withdrawals, or liquidity, and asset managers market it as a feature rather than a bug. Keeping money captive lets these funds hold assets that may be too hard to sell quickly at a fair price, at least for mutual funds or exchange-traded funds, which allow daily or even intraday withdrawals.
Indeed, positions in illiquid assets can take weeks, months, or even years to exit fully, which makes them inappropriate for ETFs and mutual funds. That hasn’t stopped those funds from investing in private assets, typically in small amounts, although both the size and frequency of those investments have been increasing in recent years.
That can be a problem. What began as a modest stake in illiquid assets in a mutual fund or ETF can act like a millstone around the investment vehicle’s neck that can sink it if sustained outflows hit. This is not a hypothetical scenario: The fund industry is scattered with real examples, such as Third Avenue Focused Credit, Woodford Equity Income, the Heartland and Principal Street municipal funds, and Fairholme.
Theoretically, semiliquid funds should be better homes for illiquid assets because of their withdrawal limitations. Here’s a look at how semiliquid funds became the current vehicle of choice for asset managers to offer private assets to retail investors.
The Growth of the Interval Fund
Of the four types of semiliquid funds—interval funds, tender-offer funds, nontraded REITs, and nontraded business-development companies—the interval fund has one of the longest and most instructive histories.
The SEC proposed the interval fund concept in 1992, not long before the first ETF’s January 1993 debut. Both fund types were, in part, attempts to fix the persistent discounts of listed closed-end funds that trade on exchanges, but the ETF has been wildly more successful. Interval funds, however, gained traction beginning in the early 2000s as a way to own broadly syndicated bank loans.
Now, an entire Morningstar Category of mutual funds and ETFs invests in these harder-to-trade loans to individual companies that banks arrange and distribute to groups, or syndicates, of asset managers. In the early 2000s, however, the investor base for them was much smaller, and many investors and asset managers considered them too illiquid for open-end funds. So, many of the earliest interval funds invested in bank loans.
In a strict sense, bank loans are private assets. They are not securities, and the owner of a bank loan can have access to material nonpublic information that can, in turn, restrict their ability to trade any public securities the company may have issued, such as a public bond or listed equity. Because these are broadly syndicated loans, the investor base typically numbers in the dozens or more. The larger the investor base, the more liquid an asset becomes.
As the bank-loan market matured and became easier to trade, more open-end funds began investing in them, and interval funds became an odd collection of individual strategies, lacking any identity. The menagerie included:
- Real estate funds, such as Bluerock Total Income+ Real Estate TIPWX, launched in 2012.
- Catastrophe-bond offerings, such as Victory Pioneer ILS Interval XILSX, launched in 2014.
- Funds that mixed public and private, liquid and illiquid assets, such as Pimco Flexible Credit Income PFLEX, launched in 2017.
There were also long-short equity, venture capital, and art funds.
The Great Convergence of Interval and Semiliquid Funds
Interval and semiliquid funds began to change in the late 2010s and early 2020s.
Consider these examples:
- Blackstone Real Estate Income Trust BREIT, a nontraded REIT that launched in 2017, has grown to $53 billion in net asset value.
- Blackstone Private Credit BCRED, a nontraded BDC, launched in 2021, and now its net asset value is $44 billion.
- Cliffwater Corporate Lending CCLFX, a private credit interval fund launched in 2019, now has more than $30 billion in assets.
Competitors have rushed to duplicate these funds’ phenomenal asset growth.
Traditional and alternative asset managers have seized on interval funds in particular, which have familiar tickers, electronic trading, tax forms, and regulatory disclosures, as the preferred vehicle to offer private assets to regular advisors and investors.
Almost all the 93 interval funds launched since the start of 2019 have offered investors access to private markets, typically private credit. Private credit encompasses many flavors, but the most common is direct lending to nonpublic, midsize companies.
Direct lending deals are like broadly syndicated loans, but the companies borrowing money are often smaller, and the loans may have just a handful of investors rather than dozens. The smaller the investor base, the less liquid an asset becomes.
There have been fewer private equity semiliquid funds. While some of those have been interval funds, the bulk have been tender-offer funds, which give asset managers more flexibility to manage redemptions. Tender-offer fund investors, for example, may not be able to withdraw their money for years so that the fund managers can put money to work in private equity and venture capital, which are even more illiquid than private credit.
Why Semiliquid Funds Are Best Suited for Private Assets
In review, private assets have found their way into a variety of semiliquid vehicles.
Nontraded REITs and BDCs are straightforward: The former invest in real estate, while the latter are required to lend to small and medium-size US companies.
Interval and tender-offer funds range more widely, but intervals have gravitated to private credit, and tender offers to the hardest-to-trade assets like private equity. Given the history and similarities with mutual funds, the interval fund market is likely to continue as a home for various strategies beyond private credit.
Private doesn’t always mean illiquid, and public doesn’t always mean liquid.
Public securities like micro-cap equity, various structured credit instruments, and some high-yield bonds can be deeply illiquid.
Similarly, broadly syndicated bank loans are private assets but are widely owned and liquid enough for mutual funds and ETFs to own. Apollo’s $11 billion deal with Intel is also considered private, but Intel INTC is a large, well-followed public company. Certain restrictions, such as post-IPO lockups or access to material nonpublic information, can make an asset simultaneously liquid and illiquid, depending on the investor.
The distinctions between public and private, liquid and illiquid, can get blurry, particularly in some parts of the credit market.
Semiliquid funds are making these often murky, less liquid private assets more accessible. With these vehicles, however, it’s more important than ever for advisors and investors to know what they own.