Interval funds and tender offer funds are two distinct investment structures that are intended to resolve the liquidity challenges that are inherent in illiquid markets and provide access to alternative assets. Despite the fact that both fund types are designed to provide investors with diversification and increased potential returns, they differ substantially in terms of their operational mechanics, redemption processes, and suitability for investors.
What are Interval Funds?
Interval funds are a specialized type of closed-end fund designed to provide periodic liquidity to investors while simultaneously facilitating access to alternative and illiquid asset classes. They combine elements of open-end and closed-end fund structures, offering the opportunity to invest in long-term, higher-yielding assets while mitigating the liquidity challenges associated with alternative investments. Interval fund repurchases are governed by Rule 23c-3 of the Investment Company Act of 1940, which outlines specific operational and redemption requirements to ensure transparency and investor protection. They are typically not listed on an exchange unlike traditional closed-end fund structures.
What Are Tender Offer Funds?
Tender offer funds are a form of unlisted closed-end fund that provides investors with discretionary liquidity opportunities through tender offers. Unlike interval funds, tender offer funds do not operate on a predefined schedule for redemptions. Instead, the board of directors determines the timing and size of tender offers, which are executed in compliance with Rule 13e-4 under the Exchange Act. This flexible structure allows fund managers to tailor liquidity provisions based on market conditions, investor demand, and portfolio considerations, making tender offer funds a versatile option for illiquid investment strategies.
Key Differences Between Interval and Tender Offer Funds
Although both fund types are registered under the Investment Company Act of 1940, they exhibit substantial differences in their redemption processes, liquidity, and structure. Below is a detailed comparison of the two fund types, highlighting their key differences.
1. Regulatory Framework:
- Interval Funds: Interval funds are regulated under Rule 23c-3 of the Investment Company Act of 1940, which mandates specific redemption intervals, notification requirements, and operational procedures to ensure transparency and investor protection.
- Tender Offer Funds: Tender offer funds are governed by Rule 13e-4 under the Exchange Act, which outlines detailed procedures for executing tender offers. Compliance requirements include filing Schedule TO with the SEC, providing comprehensive disclosures to investors, and adhering to strict timelines for each tender offer.
2. Redemption Structure:
- Interval Funds: Interval funds operate on a fixed redemption schedule, typically offering liquidity on a quarterly, semi-annual, or annual basis. During each redemption window, the fund is required to offer to repurchase a minimum of 5% and up to 25% of its outstanding shares at net asset value (NAV). If redemption requests exceed this limit, shares are repurchased on a pro-rata basis although the fund may repurchase an additional amount of stock not to exceed two percent of the common stock outstanding on the repurchase request deadline.
- Tender Offer Funds: Tender offer funds provide discretionary liquidity determined by the board of directors. Repurchase offers are not required to follow a predetermined schedule and may vary in size and frequency in accordance with market conditions, investor demand, and portfolio liquidity.
3. NAV Calculation:
- Interval Funds: Interval funds are required to calculate their NAV weekly or daily, particularly around redemption periods, to ensure transparency and accurate pricing. This frequent NAV calculation ensures that investors have an up-to-date understanding of the fund’s value and allows for consistent pricing during redemption intervals. Most Interval funds calculate their NAVs daily in order to meet DTCC’s Fund/SERV trading requirements.
- Tender Offer Funds: These funds are only required to calculate NAV at the time of a tender offer. This leads to less frequent NAV updates compared to interval funds, focusing on precision during specific events. Since tender offers may occur at irregular intervals, the NAV calculation aligns with these discretionary events to reflect the accurate value of the fund’s assets. Most Tender Offer funds calculate their NAVs monthly with a few choosing to calculate on a quarterly basis.
4. Liquidity Management:
- Interval Funds: Interval funds are required to maintain sufficient liquid assets to meet redemption requests during designated intervals. This ensures compliance with their repurchase obligations and investor expectations as outlined in their offering documents.
- Tender Offer Funds: Tender offer funds have more flexible liquidity requirements. They are not obligated to maintain the same level of liquid assets as interval funds and can time tender offers based on portfolio liquidity and market dynamics.
5. Minimum Investment:
- Interval Funds: Interval funds typically have lower minimum investment requirements, ranging from $5,000 to $10,000, making them more accessible to retail investors. This lower barrier to entry aligns with their target audience, which often includes smaller investors seeking access to alternative assets.
- Tender Offer Funds: Tender offer funds do not have a standardized minimum investment requirement and can vary widely. Some funds may have minimums as low as $1,000, while others may require a minimum of $50,000 or more, contingent upon the policies and structure of the specific fund.
Understanding these distinctions is critical for financial professionals aiming to align fund structures with their investment objectives and client needs.
Target Investor Channels
The structural characteristics and liquidity features of interval funds and tender offer funds make them suitable for distinct investor profiles and distribution channels. Here is a breakdown of the prospective investor channels for each type of fund:
Interval Funds
- Retail Investors: Retail investors are the primary target audience for interval funds. Their structure enables individual investors to access alternative investments that are typically reserved for institutional investors, as they require comparatively low minimum investments.
- Investment Advisers: Financial advisers frequently suggest interval funds to clients who are seeking higher yields through less liquid investments, such as real estate or credit strategies. Retail clients are attracted to the liquidity offered by the periodic repurchase offers.
- Various Distribution Platforms: Interval funds are more accessible to individual investors due to the fact that they can be sold through a variety of platforms, such as broker-dealers, financial advisers, and online investment platforms.
Tender Offer Funds
- Institutional and Accredited Investors: Institutional investors and accredited investors are both generally more attracted to tender offer funds. These funds are frequently utilized for private equity strategies and frequently necessitate higher minimum investments, rendering them appropriate for sophisticated investors who are interested in long-term returns.
- Brokerage Firms and Private Wealth Channels: Brokerage firms, wirehouses, and private wealth management channels are the primary targets of tender offer funds. Their adaptable liquidity options are well-suited to the requirements of high-net-worth individuals and institutions that are capable of managing the discretionary nature of repurchase offers.
- Limited Retail Access: Due to the discretionary nature of repurchases and the higher minimum investment requirements, tender offer funds are less prevalent in the retail sector than interval funds. However, some retail investors may have access to them.
Tax Considerations for Interval and Tender Offer Funds
Investors should be mindful of the fact that both funds have unique tax implications. Here’s an overview of the key tax considerations for each fund type.
- Tax Classification: If interval funds satisfy specific criteria, including the distribution of at least 90% of their taxable income to shareholders annually, they may qualify as Regulated Investment Companies (RICs) under the Internal Revenue Code. This designation will enable them to evade paying taxes at the entity level. Tender offer funds, like interval funds, have the option to be classified as RICs. This classification enables them to distribute income to investors without being subject to entity-level taxation, provided that they satisfy comparable distribution requirements.
- Capital Gains Tax: Interval funds are taxed based on their asset composition. If a fund is primarily invested in equities, it’s taxed similarly to equity funds. If it’s primarily invested in debt securities, it’s taxed as a debt fund. If the underlying securities were held for more than one year, regardless of how long the investor has owned shares in the fund, the long-term capital gains are taxed at rates of 0%, 15%, or 20%, depending on the investor’s income level. Short-term capital gains are taxed as ordinary income.
- Distribution Reporting: Interval funds and tender offer funds typically report distributions to shareholders on Form 1099, detailing the character of the distributions based on the income and gains earned during the fiscal year. This reporting is essential for investors to determine their tax liabilities and assists investors in understanding the nature of their income.
- K-1 Reporting: If an interval or tender offer fund invests in limited partnerships, it may receive Schedule K-1 forms, which report income, deductions, and credits. These items must be included in the fund’s taxable income calculations, adding complexity to tax reporting.
Key Insights: Given that tender offer funds often focus on illiquid investments (like private equity), they may generate higher returns, which could lead to higher tax liabilities when realized gains are distributed to investors. As for interval and tender offer funds, they must meet annual distribution requirements of 98% of ordinary income and 98.2% of capital gains to avoid a 4% excise tax on undistributed income.
Challenges Associated with Both Fund Types
While interval funds and tender offer funds provide access to illiquid and alternative asset classes with limited liquidity provisions, they also come with inherent challenges. These challenges arise from their structural complexities, regulatory requirements, and operational demands.
1. Liquidity Management
Both funds face significant challenges in managing liquidity due to their focus on illiquid or alternative asset classes. A delicate balancing act is required to satisfy redemption requests while simultaneously preserving long-term investments.
Interval Funds:
- It’s the responsibility of fund managers to guarantee that they have adequate liquidity to fulfil their redemption obligations as scheduled. This frequently necessitates maintaining a portion of the portfolio in cash or liquid assets, which can restrict the potential returns from illiquid investments. A line of credit is often used to assist in covering redemption requirements.
- During periods of high redemption demand, such as economic downturns, interval funds may face challenges in meeting the minimum 5% repurchase obligation without disrupting portfolio stability.
Tender Offer Funds:
- The discretionary nature of tender offers grants fund managers flexibility; however, this also generates unpredictability. The fund’s liquidity may be compromised if a significant number of investors opt to redeem shares during a tender offer, necessitating the sale of illiquid assets at unfavorable prices.
- Particularly in times of market volatility, it can be difficult to manage investor expectations regarding the timing and size of tender offers.
Key Insight: Effective liquidity management requires robust planning, stress testing, and a strategic approach to portfolio construction to balance liquidity needs with long-term investment objectives.
2. Valuation of Illiquid Assets
Both fund types often hold alternative and illiquid assets that lack readily available market prices. Accurately valuing these assets is a complex and resource-intensive process.
Interval Funds:
- Frequent NAV calculations (daily or weekly) require consistent and accurate valuations of illiquid assets. Fund managers must rely on fair value pricing methodologies, such as discounted cash flow (DCF) models or third-party appraisals, which can be subjective and prone to discrepancies.
- Investor dissatisfaction or regulatory scrutiny may result from inaccurate valuations, particularly during redemption periods.
Tender Offer Funds:
- Although NAV calculations are less frequent, they still necessitate precision during tender offers. Investors who redeem shares based on outdated valuations may be at a disadvantage due to the potential lag in asset pricing caused by the infrequency of valuations.
- High reliance on fair value estimates can introduce uncertainty, especially for niche or highly illiquid assets.
Key Insight: Investor confidence and compliance necessitate the preservation of transparent and precise valuations. Adherence to fair value accounting standards and collaboration with third-party valuation experts could mitigate these challenges.
3. Regulatory and Compliance Burden
Both funds are subject to rigorous regulatory supervision, which can be resource-intensive to manage.
Interval Funds:
- To ensure that these regulations are adhered to, it’s necessary to have dedicated administrative resources and robust systems in place to ensure that redemption obligations are met and that there is timely reporting.
Tender Offer Funds:
- The discretionary nature of tender offers adds complexity, as fund managers must justify the timing and size of offers while maintaining compliance with SEC rules.
Key Insight: A combination of proactive oversight, technology, and expertise is necessary to ensure compliance with regulatory frameworks. Penalties, reputational harm, and diminished investor confidence may ensue if regulatory obligations are not fulfilled.
4. Investor Communication and Expectation Management
Clear and consistent communication with investors is critical for both fund types, but they present unique challenges.
Interval Funds:
- Investors must be informed of redemption windows in advance, including the percentage of shares eligible for repurchase and the pro-rata allocation mechanism if redemption requests exceed the maximum permitted.
- Particularly when redemption requests are prorated, managing investor expectations regarding liquidity and performance during volatile markets can be challenging.
Tender Offer Funds:
- Fund managers must communicate the terms and timing of each tender offer explicitly due to the discretionary nature of the offers. Dissatisfaction among investors may result from any delays or changes to tender offer schedules.
- In order to prevent misunderstandings, it’s imperative to inform investors about the fund’s illiquid nature and the implications of discretionary liquidity.
Key Insight: Proactive investor communication, combined with detailed disclosures, can help mitigate dissatisfaction and align investor expectations with the fund’s operational realities.
5. High Fees
In comparison to traditional mutual funds or exchange-traded funds (ETFs), both fund types typically incur higher fees. The operational complexities, management expertise, and due diligence necessary to effectively manage alternative assets are reflected in these fees.
- Interval Funds:
- The average expense ratio for interval funds is approximately 2.49%, significantly higher than ETFs (0.58%) and mutual funds (0.99%).
- This includes management fees that can range from 1.5% to 2.45% and additional service and operating fees that can further increase total expenses.
- Interval funds may also impose sales charges that can start as high as 5.75%, adding to the overall cost of investment.
- Tender Offer Funds:
- The total estimated gross expenses for tender offer funds can range from about 2.40% to 3.43%, depending on the specific fund and its fee structure.
- Management fees for tender offer funds can reach around 2% annually, with additional performance-based fees that are comparable to those observed in private equity funds.
- Many tender offer funds include an incentive fee, which may be set at approximately 12.50% of any profits earned, subject to a high watermark provision.
- Some funds charge distribution and servicing fees, which can range from 0.25% to 0.85% annually.
Key Insight: The higher fee structures of both fund types may discourage cost-conscious investors and require transparent fee disclosures to prevent dissatisfaction.
In order to ensure the successful operation of these intricate investment vehicles and maintain regulatory compliance and investor confidence, fund managers and financial professionals must understand these challenges and devise effective strategies to overcome them.
Choosing the Right Fund Type for Your Investment Strategy
Choosing the appropriate fund type depends on your investment strategy, liquidity needs, and the types of assets you intend to include in your portfolio. Here are the key aspects to consider:
- Consider Your Liquidity Needs: Liquidity is a critical factor when choosing between interval funds and tender offer funds. The interval fund structure offers some liquidity; however, it may not be sufficient to satisfy immediate cash requirements if investors require access to their capital outside of the redemption periods. Although tender offer funds provide more flexibility regarding repurchases, there is no guarantee that investors will be able to redeem all their shares during a tender offer, especially if demand exceeds the amount offered for repurchase.
- Investment Strategy: Take into account the assets that each fund typically invests in. Interval funds often focus on real estate and credit strategies, while tender offer funds have gained popularity for private equity strategies. If your investment strategy aligns with these asset classes, it may influence your choice. Tender offer funds may be more appealing to investors who are at ease with less frequent liquidity but are willing to accept the potential for higher returns from alternate investments. In contrast, interval funds may be more appropriate for those seeking a longer-term investment horizon with periodic liquidity.
- Fee Structure: Evaluate the fee structures of both fund types. Interval funds typically have higher average expense ratios than traditional mutual funds and ETFs, and tender offer funds also tend to have elevated fees as a result of their performance-based structures and management. It is imperative that you understand the extent to which these fees affect your overall returns.
By aligning these factors with your financial goals and risk tolerance, you can make a more informed decision that suits your investment objectives.
How Ultimus Fund Solutions Can Help
At Ultimus Fund Solutions, we specialize in providing comprehensive services to support the administration and operation of both interval funds and tender offer funds. Our team of seasoned professionals understands the unique complexities and regulatory requirements associated with these investment vehicles. From fund launch to ongoing administration, we deliver customized solutions to streamline your operations, enhance compliance, and optimize investor communication.
- Regulatory Expertise: We ensure your fund remains compliant with the intricate requirements of Rule 23c-3 under the Investment Company Act and Rule 13e-4 under the Exchange Act. Our regulatory team offers proactive oversight, ensuring that filings, disclosures, and compliance with SEC regulations are met.
- NAV Calculations and Valuations: We offer robust NAV calculation and valuation services that are specifically designed for alternative asset classes. We cultivate investor confidence by guaranteeing precision and transparency through the implementation of fair-value pricing methodologies and advanced technology.
- Liquidity and Redemption Management: Our solutions incorporate sophisticated liquidity management strategies to assist your fund in maintaining a balance between long-term portfolio objectives and investor redemption obligations. We ensure operational efficiency by administering discretionary tender offers or interval fund redemption schedules.
- Investor Communication Support: Clear and consistent communication is indispensable for investor confidence. Ultimus offers comprehensive investor reporting, which encompasses the distribution of Form 1099, detailed fund updates, and notifications of redemption opportunities.
- Fee Transparency and Reporting: With expertise in accounting and reporting, we ensure full transparency in fee structures, helping you communicate effectively with investors while maintaining operational clarity.
We are well-positioned to offer cost-effective, high-quality fund administration services to institutional fund managers, financial advisers, and investment firms as a result of our dedication to providing customized, scalable solutions. Partnering with Ultimus means leveraging industry expertise to overcome operational challenges and achieve your investment goals. Contact us today to learn more.
COD00000552 11/18/2024
