The global financial crisis continues to have its effect on the preferences of the American investor. Those who thought they had achieved diversification with an allocation of mutual funds found themselves whipsawed when most asset classes fell in unison during the crisis. Now many investors, including the mass affluent, are demanding more sophisticated investment choices.
Historically, access to alternative private investment opportunities has been for institutional investors, but now the mass affluent are demanding this access as well. In turn, a new product type, the interval mutual fund, is providing the next evolution in alternative investing.
These simply are a mutual fund that offers daily purchase for investment but liquidity for limited redemptions at specific intervals (usually quarterly). This change to the mutual fund structure creates large advantages; the fund can simultaneously invest in both private and public assets in a structure that has a liquidity feature and a daily net asset value. This allows the sponsor to create a portfolio of investments that may provide higher levels of yield and noncorrelation to equities, but without the illiquidity and lack of price transparency.
Interval mutual fund investment strategies will differ and can be used to invest in many different alternative assets. However, there are a few essential aspects advisers should consider when examining the merits of such a fund:
Investment strategy: Understand what asset classes the portfolio comprises and have a strong understanding of the largest positions in the fund.
Internal investment management versus fund-of-funds approach: This relates to whether the fund outsources investment management or keeps this function in house. I believe that this is a very important function that should be performed by the fund's sponsor, allowing better risk control and more accountability, in addition to potentially lower costs.
Level of liquidity and transparency: The liquidity feature of the interval mutual fund structure is an important characteristic. Hence a significant level of liquid assets held in the fund will ensure the ability to meet redemptions. Further, the significant weight to liquid assets improves pricing transparency for investors.
Conflicts of interest: Conflicts can arise if the portfolio manager is allowed to invest in other funds of the sponsor. The most transparent outcome (to ensure no conflicts) is to preclude the fund from investing in other funds of the sponsor.
Blending different real estate investment types, moving beyond traditional publicly traded or nontraded real estate investment trusts, has the ability to optimize a real estate allocation by capturing the benefits of each but also mitigating individual disadvantages.
For example, investing directly in real estate through institutional private equity produces moderate yield and growth, and sector diversity, but does not provide the regular liquidity feature. Publicly traded REITs give access to global investment, nontraditional asset types, liquidity and growth, but come with a lower yield and equity market correlation. Debt can give you yield and principal protection, but can fall short on interest rate hedging ability. As such, the features of an interval fund aims to deliver the best features of each category while mitigating most risks.
Scott Crowe, portfolio manager for resource real estate, developed an expertise in interval mutual funds by managing the Resource Real Estate Diversified Income Fund, which invests across real estate asset types.