Thirst for diversification leads more advisers to interval funds

They're trading liquidity for access to asset classes normally out of reach for retail investors

Apr 16, 2019 @ 3:34 pm

By Jeff Benjamin

With the bull market now a decade old, financial advisers are showing an increased willingness to give up investment liquidity in exchange for strategies that don't move in sync with the broad equity markets.

Interval funds, named for their strict limits on investor redemptions, represent a small but suddenly fast-growing investment category that is becoming the go-to diversification strategy for some advisers.

"The funds give clients exposure to primarily illiquid underlying investments without having to be an accredited investor," said Matt Chancy, a financial planner at Claraphi Advisory Network.

Mr. Chancy, who is currently allocating about 20% of client portfolios to interval funds, said the fact that clients can only redeem their investments monthly or quarterly is more of a positive than a negative.

"When you make a portfolio allocation at the start of the process with a client, you understand the client's need for liquidity and cash flow, and you structure portfolios accordingly," he said. "There's plenty of research that says there's a premium you give up for liquidity."

Because interval funds generally invest in illiquid areas such as private real estate, private lending and reinsurance policies, that limited liquidity is considered a portfolio management necessity, which proponents of the strategy strongly defend.

"I like to be able to access asset classes that can't be easily accessed in other ways for most investors, and the structure helps protect client returns from hot money moving in and out," said Eric Walters, president of Silvercrest Wealth Planning.

Mr. Walters, who allocates between 2% and 7% of client assets to interval funds, is currently using funds that allow for monthly redemptions.

"I'd be happy with quarterly or even annual redemptions, as long as it's not the kind of multiyear lockups you see with private equity and hedge funds," he said.

Net of fees, which tend to be higher than mutual fund fees, Mr. Walters said his clients are earning between 6% and 7% annually from interval funds invested in small business loans.

Interval funds, like mutual funds, are registered under the Investment Company Act of 1940. They were first introduced in 1990 as a way to hold less liquid investments in a retail-oriented fund.

According to the Interval Fund Tracker website, there are currently 64 interval funds managing nearly $30 billion, with another 20 funds awaiting approval by the Securities and Exchange Commission.

The pace of growth is significant, with 18 new funds launched last year and 10 funds launched in 2017. Assets at the end of 2018 were up 41% from the end of 2017, according to Interval Fund Tracker.

As recently as 2011, total assets in interval funds were under $5 billion. But this is a category that has ebbed and flowed, as illustrated by the nearly $20 billion in total assets at the last peak in 2007.

While some advisers stand behind redemption policies, which usually are capped at 5% of a fund's total assets per redemption period, the commitment to longer-term investing can backfire.

The Stone Ridge Reinsurance Risk Premium Interval Fund, for example, is currently dealing with a flood of redemption requests following two years of poor performance, which resulted from storms and natural disasters negatively impacting the reinsurance industry.

The fund declined by 6.1% last year compared to a benchmark gain of 2.4%, and it was down 11.6% in 2017 compared to a benchmark decline of 0.1%.

New York-based Stone Ridge Asset Management, which manages $16 billion across multiple funds, did not respond to a request for comment for this story.

Dick Pfister, founder and president of AlphaCore Capital, described the Stone Ridge situation as an example of investors not being properly matched to the investments.

"From a top-down perspective, interval funds are an excellent wrapper for strategies that are less liquid," Mr. Pfister said. "You want to bring unique strategies to investors, but if it's so unique that investors don't understand what could happen, you end up with this quintessential mismatch of liquidity."

But while some investors are clamoring to get out of the Stone Ridge fund, not everyone is in full panic mode.

"It's not surprising to me, because it looks like normal investor behavior after two down years," said Jeffrey Nauta, principal and chief compliance officer at Henrickson Nauta Wealth Advisors, which has $15 million worth of client assets invested with Stone Ridge.

"We're not concerned," Mr. Nauta said. "We think the reason the [redemption] gates are there is to prevent the fund from having to sell assets at fire-sale prices."

0
Comments

What do you think?

View comments

Upcoming event

Oct 22

Conference

San Francisco Women Adviser Summit

The InvestmentNews Women Adviser Summit, a one-day workshop now held in six cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Most watched

Events

Finding innovation in your firm

Adam Holt of AssetMap explains how advisers understand they need to grow, but great innovation may be lurking right under your nose.

Events

Finding your edge from Tony Robbins

Guru Tony Robbins has helped a lot of people, but armed with his psychology Financial Advisor Josh Nelson has helped his practice soar.

Latest news & opinion

The growth of factor-based investing

Advisers are making decisions about clients' portfolios by using the same characteristics that govern factor-based ETFs.

Finra makes its list to target hundreds of rogue individuals

The regulator sees patterns in the behavior and disclosures of high-risk brokers.

LTC insurer offering co-pays to blunt soaring premium increases

John Hancock policyholders would get a discount on their premium in return for agreeing to pay a bigger portion of their claims in the future.

Goldman Sachs acquires United Capital

After a payday of $75 million or more, CEO Joe Duran plans to join Goldman in a senior position.

Private equity loves IBDs, but will that last?

Three big acquisitions in less than a year signals renewed life in the formerly beleaguered industry.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print