The Private Credit market has been expanding steadily across the globe due to several factors including higher risk-adjusted returns, hedge against inflation, diversification to non-public markets, lower volatility in an otherwise volatile public market, and access to unlisted high-growth companies. However, investors often hesitate to access the Category II private credit alternative investment fund (AIF) market due to re-investment risk caused by multiple capital calls and five-to-seven-year lock-in of funds. Semi-liquid funds aim to address some of these concerns.
Semi-liquid funds are an investment vehicle in illiquid private credit markets while providing investors some flexibility to subscribe and redeem at regular intervals. Specially crafted for HNIs/UHNIs and family offices, these funds are structured as open-ended vehicles and are suitable for investors who are unable or unwilling to invest in closed-ended funds (Category II funds) due to lack of interim liquidity.
The term “semi-liquid” implies that the funds provide some degree of liquidity via periodic redemptions allowing investors to retrieve part or whole of their capital during the investment period. This offers more flexibility than traditional closed-ended funds (like Category II private credit AIFs). They are also known as Evergreen funds as they allow regular capital inflows and outflows for investors. With these, semi-liquid funds effectively bridge the gap between debt mutual funds and the private credit market.
The origin of semi-liquid funds can be traced back to 1992 when the Securities and Exchange Commission (SEC) in the US recommended the creation of a new form of open-ended investment vehicle known asInterval Funds. The momentum in interval fund launches began in 2018 and it is estimated to have cumulative assets under management (AUM) of ~US$1 trillion globally. Credit strategies form a major part of the semi-liquid funds in the US, with credit being 66% of the overall AUM under interval funds (like Semi-Liquid funds/ perpetual vehicle).
Advantages of Investing in Semi-Liquid Structures
Access to private credit through a flexible structure: HNIs, UHNIs, family offices and investors have been diversifying their portfolios with private credit funds for their low correlation with public markets and potential for higher risk-adjusted returns and inflation hedge. In the US, high-net-worth investors allocated 15-20% of assets to private markets in 2023 (BCG). Investing in private credit can also align well with a lower interest rate environment adopted by several central banks across the world.
Amid demand for private credit, demand for structures like semi-liquid is expected to grow due to their open-ended setup giving investors access to the private credit market through a single drawdown and a flexible redemption and cash flow, basis investor’s need.
Further, returns from semi-liquid funds are not prone to opportunity loss or re-investment risk caused by multiple capital calls and cash distributions of income (irrespective of whether investor needs) and principal run-down in tranches, which may expose the investor to re-deployment and re-investment risk.
In traditional private credit funds, which are typically close-ended, actual returns from the date of commitment may differ from what was communicated due to (a) opportunity loss during the initial waiting period (when funds are drawn down in tranches) and (b) a lag or difference in re-investment yield on account of income and principal distribution. As per estimates, the overall drag can be 0.5-1% p.a., on a pre-tax basis, in investor’s actual returns.
In semi-liquid funds, gross returns may be around 1–1.5% lower compared to traditional private credit funds. However, the aforementioned cash drag causes net returns (post-expenses, post-tax) from semi-liquid funds to be comparable to those from private credit funds, as semi-liquid funds begin generating returns for investors from the day the entire committed capital is invested.
Liquidity and flexibility: Semi-liquid funds can appeal to investors seeking entry into the private credit market while maintaining periodic redemption. These funds enable faster deployment of investors’ capital (unit allotment can happen every fortnight) providing them with both liquidity and flexibility.
Usually, the overall redemption is capped at 5-10% of AUM, but there is no cap on redemption at the investor level. The redemption is predominantly allowed every quarter, and the investor can place a redemption request 15 to 30 days prior to the end of any quarter. Assuming a 10% gating, if the amount of redemption requests is less than or equal to the amount as per 10% of the AUM, investors get full exit. If the redemption request exceeds the 10% gating, exit to investors is provided on a pro-rata basis. In such cases, those investors are allowed to place another redemption request in the next quarter.
Further, semi-liquid funds allow investors to reinvest their income automatically into newer investments, if they choose to do so. If not, they can remain invested for the long term without the need for periodic investment decisions.
Relief of wealth advisors from repeated due diligence: Wealth advisors/private bankers need to perform due diligence on the fund manager and the fund strategy for traditional closed-ended private credit funds repeatedly with every commitment. However, semi-liquid funds relieve them from doing so by underwriting upfront instead of continuously engaging in a new process every time.
Operational ease: In Semi-liquid funds, capital commitment takes place in a single tranche avoiding the need for periodic capital calls as in a traditional fund. This makes operations simpler for investors and their advisors/private bankers.
Semi-liquid funds are finding increasing interest globally for their flexible structure. They provide an alternative to traditional private credit funds for investors seeking exposure to the private credit market. Private Credit as an asset class is well suited to investment through a semi-liquid structure. At the same time, these funds present opportunities that may not be available in a close-ended fund. Availability of semi-liquid structures in India’s alternative industry is expected to grow gradually over time.
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