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."
