Interval funds continue to attract attention from investors as they become better acquainted with the features of the vehicle. According to Morningstar, the number of new interval fund launches hit double digits in 2017 and has averaged 12 per year since then through 2023. As of midyear, 2024 is on track to see the most launches yet.
Meanwhile, interval funds’ assets under management have grown almost 40% annually to $80 billion over the 10 years through April 2024, based on Morningstar data. We would attribute this impressive growth to several clear investor benefits associated with the semi-liquid aspect of the vehicle, which still retain many of the familiar characteristics of traditional mutual funds. These include:
- Five-letter ticker symbols
- Registration under the Investment Company Act of 1940
- Daily pricing of net asset value (NAV)
- Daily subscriptions, or the ability to purchase shares on any trading day at closing NAV
However, it’s the differentiators that really explain the investor appeal. While traditional mutual funds offer daily liquidity, interval funds limit share redemptions to specific, defined “intervals,” with quarterly share repurchases as the standard. This means investors can redeem shares on four specific dates each year, as outlined by the fund’s share repurchase schedule.
Here, we focus on five of the most important potential benefits of the quarterly redemption feature through the lens of credit-focused interval funds.
1. The flexibility to invest in ideas with higher-return potential
Interval funds allow investors access to certain assets that may otherwise be out of reach in more traditional investment vehicles. These assets may be characterized by lower liquidity and/or greater complexity, requiring a stronger focus on research and specialization in the investment process. Additionally, they may often stray from traditional benchmark-like risks. These characteristics often result in exposure to investments with higher-return potential that are typically not found in “regular way” credit funds. A longer time horizon provides managers with the ability to invest with greater conviction in such ideas and focus on idiosyncratic credit selection versus generic exposure to an asset class.
Thinly traded, complex, or unique securities, which are typically passed over in traditional mutual funds, can be an appropriate opportunity set for interval funds. For example, the Lord Abbett Credit Opportunities Fund may invest in asset-backed securities (ABS) residuals or collateralized loan obligation (CLO) equity securities1 that might not be purchased in our traditional fixed-income funds, at least not in meaningful size. What’s more, the Credit Opportunities Fund may be the sole investor in an entire debt tranche of a specific ABS deal, given the combination of our conviction in the investment and the extended time horizon of the vehicle structure.
2. Closer alignment of the liquidity profile of the underlying investments with the fund structure
While interest-rate risk and credit risk take most of the spotlight for fixed-income fund investors, asset/liability mismatch is one risk often overlooked. While this risk is mostly associated with banks that model their business on borrowing short and lending long, it may also be tied to credit-oriented investment vehicles purchasing intermediate- or long-term debt while offering daily liquidity. While interval funds are not perfectly asset/liability matched, their longer-term investment horizon does offer closer alignment between the underlying investments and the overall fund structure relative to those funds offering daily liquidity.
3. The ability to be an opportunistic buyer during periods of forced selling
Opportunistic credit funds seek to monetize the frequent disconnects between market prices and the true values of securities. These disconnects can stem from market-wide dislocations such as the “tech wreck” of 1999–2000, the global financial crisis (GFC) of 2008–09, or the onset of the COVID-19 pandemic in 2020. Dislocations can also be identified on a more local level—appearing often across different sectors, subsectors, and issuers, at different times and in varying magnitudes. In markets characterized by dislocation and heavy selling pressure, mutual funds that offer daily liquidity may be forced to sell holdings to raise enough cash to meet investor redemptions. This forced selling often results in otherwise sound investments being priced at a discount to what fundamentals would imply.
Conversely, interval funds can be opportunistic buyers in such environments, potentially insulated from redemptions and on the offensive to capture misvalued investments discarded for the wrong reasons. For example, during the pandemic-related market disruptions of early 2020, many asset managers were offering securities for sale to accommodate investor share repurchases. This resulted in the disposal of high-quality assets at steep discounts, given the impact of a high cost for liquidity charged by those in a position to bid for such risk. As an interval fund, the Credit Opportunities Fund was a liquidity provider, with no redemptions to meet at the apex of market-wide selling pressure. As a result, the Fund increased its investment-grade exposure, taking advantage of quality assets that could be obtained at steep discounts.
4. A longer investment time horizon that allows for catalyst realization
Investment ideas involving market dislocations often need time to “play out.” The Credit Opportunities Fund’s portfolio management team seeks to identify a catalyst for each investment candidate that will drive spread compression. In addition to identifying the potential catalyst, the team also quantifies the time frame—for which that precipitating event is expected to close the gap between their differentiated fundamental view and that of the market. Often, that time frame can include several quarters. Therefore, the quarterly redemption feature of the interval fund structure allows the investment team to “stay until the end of the movie,” remaining invested until the catalyst has been recognized by the market and their price targets realized.
This concept applies to investments across the liquidity spectrum. In other words, while a longer time horizon provides managers with the ability to invest with greater conviction in ideas with low liquidity, the benefit also applies to liquid securities. Just because a security is deemed liquid and can be sold easily and without the price impact of a meaningful liquidity cost, does not mean selling the security is the right decision. A manager insulated from significant redemptions can be a seller on his or her own terms, waiting until the catalyst is recognized by the market, regardless of the degree of liquidity associated with the security.
5. Greater visibility with respect to future investor redemptions
Finally, daily liquid mutual fund managers have limited transparency with respect to the timing or severity of notable “waves” of outflows. They must be ready to meet significant redemption requests daily. In contrast, managers of strategies available through an interval fund have clear visibility with respect to when redemptions will be due (i.e., four defined dates in the fund’s fiscal year). With respect to severity, redemption requests are monitored each day leading up to the request deadline. This visibility, combined with the proration feature that’s triggered when redemption requests exceed 5% shares outstanding, allows managers to invest with greater conviction and ensure they are well-prepared to meet investor requests to redeem shares.
A Final Word
The impressive growth of interval funds is not surprising, given the appeal to investors of accessing institutional-caliber strategies and investments in a vehicle that offers the convenience and degrees of familiarity shared with traditional mutual funds. We are proud of the growth we’ve experienced in this space and emphasize the fact that opportunistic credit is an integral pillar in our alternatives platform. We’ve been investing in the leveraged credit markets since 1971. Over the years, our investors recognized an opportunity to apply our expertise to idiosyncratic ideas that may exhibit lower liquidity, greater complexity, and higher-return potential than more traditional credit issues through concentrated, high-conviction portfolios.
