Vanguard founder John Bogle repeatedly warned, “The miracle of compounding returns is overwhelmed by the tyranny of compounding costs.” He wasn’t talking about semiliquid funds, but he could have been.
Semiliquid funds don’t just provide access to private markets, they often layer on high and complex fees. Some are visible in the headline numbers. Many are not.
Financial advisors surveyed by Morningstar ranked fees and fee transparency as a top concern for evaluating private market funds in the forthcoming 2025 Voice of the Advisor.
In early September, our manager research team will launch its first set of Morningstar Medalist Ratings for semiliquid funds. Like mutual funds and exchange-traded funds, we evaluate them on key factors such as investment process, management, performance, and fees but adapt our established approach to the unique characteristics of semiliquid structures. In this article, we’ll explore the key role of fees. We also examine performance, investment process, management, and parent firms in related articles.
It’s vital to make sure the fees won’t sabotage future returns. Here are five things every investor should know about semiliquid fund fees.
1. Fees still matter.
Funds that invest in private equity, credit, and real estate have always come at a much steeper price than those that invest in public stocks and bonds.
The exhibit below shows the median and average prospectus-adjusted fees across different fund types. Target-date funds represent how much a broadly diversified portfolio of stocks and bonds that’s professionally managed costs investors today. Interval funds tilt more toward public and private credit. Tender-offer funds lean more heavily on private equity.
Today, target-date funds offer all-in-one portfolio solutions for a median fee of less than 0.60%, and many charge 0.10% or less. Those low costs are a big reason target-dates have delivered impressive results for investors in the last decade. Interval funds and tender-offer funds must clear much higher hurdles; they respectively charge nearly 4 and 6 times the target-date median. Competition should drive down semiliquid fund costs. Some new entrants, like the hybrid public/private credit funds Capital Group recently launched with KKR, are already giving themselves a head start on fees. Meanwhile, low-fee advocate Vanguard plans to enter the fray with Wellington Management and Blackstone later this year. The firms haven’t disclosed fees yet, but they should be low for semiliquid funds.
2. Different fee structures make it tricky to compare funds.
One challenge when evaluating semiliquid fees is comparing funds that don’t charge performance fees with those that do. It helps to form some expectations about expected returns.
To illustrate, let’s use a simple example that focuses on income rather than capital gains:
Fund A: Charges a high management fee of 2.5% and no incentive fee.
Fund B: Charges a management fee of 1.25% but also charges a 12.5% incentive fee on income. (This is a common fee structure for nontraded business development companies.)
The exhibit below shows how the total fee (management fee + performance fee) changes at different gross income levels.
Investors in Fund A are going to pay 2.5% regardless of the amount of income the fund generates. Investors in Fund B will see their total costs rise as the income grows, up to nearly 4% for a 20% gross return. If both funds generate 10% in gross income, then the fees are about equal. Knowing this, an investor can use their expected return to get a sense of how much they can expect to pay and compare funds on even footing.
3. Performance fees add up faster than management fees.
It feels natural to think higher returns make higher fees worth it, but the math doesn’t always work out for investors. Using the assumptions above, let’s look at the impact of the ending balance of a $10,000 investment in both funds using the same return scenarios.
Higher returns don’t always translate to better investor outcomes after considering performance fees. The company offering Fund B is likely happy with the outcome, but investors would have been better off with the high management fee charged by Fund A.
4. Always expect to pay the full performance fee on income.
In theory, performance fees are meant to motivate managers to deliver strong returns. In practice, many funds have little difficulty collecting these fees, especially when they are based on income rather than overall performance.
Semiliquid funds that charge performance fees on income often include a hurdle rate that they must clear before they can start collecting their additional fees. The hurdle rate is typically 5%. This appears to be an investor-friendly mechanism that prevents the managers from charging fees on low levels of income. There are two problems with this approach, though.
Most funds also include a full catch-up provision that allows them to collect additional fees after they clear the hurdle to make up for the missed fees on the first 5% of income. Exhibit 3 shows how a typical hurdle rate with a full catch-up works for a fund that charges a 12.5% incentive fee on income with a 5% hurdle rate.
The net effect is equal to if the managers had charged the performance fee the entire time. You can find a more in-depth breakdown of catch-up fees here.
Another challenge with hurdle rates is that they are often set very low, making them easy to clear. Take, for example, the common 5% hurdle rate. Most private credit interest payments are tied to a benchmark, typically the secured overnight financing rate, plus a spread. Over the past year, SOFR has averaged about 4.8%, meaning that cashlike instruments alone were already close to clearing the hurdle. Even when interest rates were near historic lows, funds could simply structure loans with interest payments above the hurdle.
5. Not all fees show up in the expense ratio.
Some semiliquid funds gain private market exposure by investing in other semiliquid funds. With the Securities and Exchange Commission relaxing limits on how much retail interval and tender-offer funds can allocate to private funds, we expect more of these products to launch. But this structure raises two issues: potential liquidity mismatches and fee layers that make it harder for investors to see the true all-in cost.
When a fund invests in another fund, it must disclose the acquired fund’s fees in the fee table of its prospectus. These fees do not show up in the annual report expenses. For investments in traditional mutual funds and ETFs, this is relatively straightforward: The underlying fund fees are asset-weighted and then added to the overall expenses of the fund.
Private funds, however, introduce another layer with performance fees. These fees can have a big impact. They are often 10% to 20% of a fund’s income or capital gains, and they are usually not included in the acquired fund fees.
This means that for funds investing heavily in private funds, such as secondary funds, the stated expense ratio may look lower than the true cost of owning the portfolio. Because most private funds lack public transparency, investors cannot realistically calculate these extra costs on their own.
The SEC’s updated guidance on the issue does address the fees, noting that funds should consider disclosing the effect of underlying private fund performance fees. However, there doesn’t appear to be a clear consensus on how those fees are disclosed yet. Greater transparency into these fees will help investors make more informed decisions on the funds they are considering.