In response to growing demand from individual investors looking for access to private markets, an increasing number of asset managers are marketing fund structures that prioritize liquidity, flexibility and simplicity for financial advisors and their clients. While many of these structures seem appealing to individuals at first glance, they unfortunately often constrain the asset manager and drag down the return potential of the fund.
This vulnerability is particularly true for funds investing in private equity (“PE”). At ALTI, we strongly believe the long-term and risky nature of PE investing warrants a structure that accommodates a long-term investment approach. In this blog we’ll describe some of the tradeoffs between different fund structures to help you understand the differences.
Over the past decade a variety of fund categories have emerged that are often confused or mistakenly used interchangeably. Let’s take a moment to understand the distinctions between two sets of funds: 1) term vs. evergreen funds, and 2) tender offer vs. interval funds.
Term Funds vs. Evergreen Funds
A term fund, sometimes referred to as a closed-end fund, has a fixed life span, usually ranging from 5 to 10 years. During an initial period, the fund raises capital from investors, and invests the funds; then the fund distributes the returns as the underlying investment liquidate or at the end of the term. Once the term expires, the fund is fully liquidated, and any remaining proceeds are distributed to investors. Investors typically cannot redeem their investments in a term fund before the end of the term, and new investors cannot join the fund once the term’s commitment period has begun. There are exceptions to these characteristics which we will discuss below in the comparison of tender offer vs. interval funds.
In contrast, an evergreen fund, also known as an open-end fund, has no fixed life span and operates indefinitely without a mandated return of capital. Investors can almost always buy and sell shares in the fund, and the fund continuously raises capital and invests it in accordance with its investment strategy. Many mutual funds and ETFs are evergreen funds.
Tender Offer Funds vs. Interval Funds
Tender offer funds allow investors to sell their shares back to the fund at periodic intervals, usually at least twice per year, and the threshold for how many shares will be accepted is usually at the discretion of the fund’s board. These funds may provide some degree of liquidity to investors, at the discretion of the board, through the tender process but do not guarantee liquidity will be available at any specific time during the life of the fund. Typically, tender offer funds will hold a percentage of the portfolio in cash to satisfy the periodic tender offers and the fund board can take into consideration the amount of liquidity available when they determine what percentage of the fund’s shares will be allowed to be tendered. The fund is required to send a notice to all shareholders to let them know the amount of shares they will accept and the deadlines to submit the request for redemption. If more shares are submitted than authorized, then the fund board will determine a fair allocation and shareholders may only be able to redeem a portion of the shares they requested to redeem.
Interval funds, on the other hand, are required to offer liquidity to investors, and they do so at set intervals, with redemption frequencies usually every 3, 6, or 12 months. They continuously raise assets and have periodic redemptions that must be met with at least 5% liquidity (and up to 25%) on an ongoing basis.
The key distinction between tender offer and interval funds is that tender offer funds may offer periodic liquidity by making repurchase offers, but are not obligated to do so on a set schedule, whereas, interval funds must provide liquidity on a defined schedule.
For several reasons, we believe that the marriage of the tender offer + term fund structure is the most similar to investing in private assets directly while also preserving the potential for increased liquidity not available in traditional term structure private equity funds.
- Tender offer fund managers are not required to maintain as much liquidity as interval fund managers since the periodic liquidity is not required, reducing the potential for a drag on the overall performance of the fund.
- Since a term fund has a fixed life span, similar to a traditional private equity fund, the fund manager can have more control over their investment strategy and can plan investments with a clearer goal in mind.
- Since a term fund has a fixed fundraising period, it does not have new capital to put to work after the fundraising period and can therefore, spread investments over several vintage years, benefitting from vintage year diversification.
- The Board of Trustees for tender offer funds have flexibility in determining when and whether to offer redemptions within certain regulatory guidelines. This allows them to evaluate whether offering a repurchase is in the Fund’s best interest given prevailing market conditions.
- Tender offer funds do not have to be as concerned about liquidating investments if redemption requirements exceed cash on hand. Liquidation of assets could occur at suboptimal times for an interval fund such as during a market downturn, which would disadvantage all of the fund’s investors. On the other hand, redeeming investors may end up with better returns if they time the market to their advantage, since their payouts from redemptions will be based on NAVs that may include appreciated assets. If the values of these same assets ultimately decline, investors who have not requested similar redemptions at that same time could suffer lower returns.
- In a term fund, similar to a traditional private equity fund, new investors cannot join the fund after the initial commitment period and dilute existing investors’ ownership stakes, as may be the case with interval funds.
- Compared to interval funds, term limit funds more closely resemble traditional PE funds. They raise capital for a specified period, invest over the next few years and then return capital to investors as the investments realize their goals and liquidate. Other than distributions from dividend and interest income, they primarily offer liquidity only as investments are exited. Therefore, term funds combined with the tender offer structure benefit from the best of both a traditional PE fund with enhanced liquidity.
Conclusion
Although individuals invested in a term + tender offer fund forego some options for liquidity that are offered through interval fund structures, they are able to access a fund structure that is more closely aligned with a traditional PE fund structure without some of the complications inherent in a traditional private asset fund, such as high investment minimums, unpredictable capital calls, and delayed K-1 tax forms.
Financial advisors and their clients should always keep in mind that private equity investing is risky and illiquid, as investments are typically made in companies that are not yet publicly traded or are undergoing significant changes that may take years to pay off. PE investing is not for everyone: it should only be considered by individuals who have a long-term investment horizon, do not need liquidity in the short-term, and are willing to assume a high level of risk. As more entrants come into the space, investors should evaluate fund structures that satisfy their individual needs and are suitable to their specific circumstances.
IMPORTANT DISCLOSURES:
PROVIDED FOR INFORMATIONAL PURPOSES ONLY. This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her advisors. Investing entails risk, including the possible loss of principal. There can be no assurance that any investment or asset class will provide positive performance over any period of time. Past performance does not guarantee future results.
The statements contained herein reflect the opinions of ALTI, LLC (“ALTI”) as of the date written. Certain statements are forward looking and/or based on current expectations, projections, and information currently available to ALTI. Such statements may or may not be accurate over the long-term. While we believe we have a reasonable basis for our comments and we have confidence in our opinions, actual results may differ from those we anticipate. We cannot assure future results and disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. Statistical data was taken from sources which we deem to be reliable, but their accuracy cannot be guaranteed.
ALTI, LLC, is a registered investment adviser.