The number of new traditional closed-end funds opening up has dropped over the past two years, with fund companies combining different offerings in a bid to wring out savings on overhead. But there's one segment of the closed-end fund world that's growing fast -- so-called "interval" funds, which have nearly doubled in number over the past two years and now account for about a sixth of all closed-end funds.
While classified as closed-end funds, interval funds typically don't trade on exchanges as most closed-end funds do. Investors are also only able to sell a restricted number of shares at regular intervals, such as quarterly.
But this gives interval-fund managers more freedom than their open-end fund counterparts to pursue illiquid but potentially highly profitable investments, like real estate or corporate loans.
Not everyone is sold on the concept, with critics pointing to higher fees and potentially higher risk. But the stock market's recent turmoil has investors taking a closer look at interval funds, which have features that boosters say can provide an edge during uncertain times.
"I expect interval funds will undergo explosive growth," says Michael Terwillger, portfolio manager of the Resource Credit Income Fund, a closed-end interval fund. "In my view, interval funds have a structural advantage [that] better helps protect principal and helps to generate higher returns."
The number of interval funds is on the rise, with 21 started so far this year through September. That comes after a 2017 that saw 25 funds launched. By comparison, fund companies and other players rolled out just 12 traditional closed-end funds last year and just one fund so far in 2018, according to Tom Roseen, head of research services for Lipper, Refinitiv.
All told, interval funds now account for 102 of the 647 closed-end funds currently in business, Roseen says. "Something is changing in the environment," Roseen says.
One big factor driving interest in interval funds is the seeming protection they provide against the ravages of a fire sale should the market go into a major funk.
Once investors buy into an interval fund, they can only get out during regular intervals set by the fund -- typically quarterly, bi-annually or even just annually.
During these redemption periods, the fund will offer to buy back, at net asset value, anywhere from 5% to 25% of the fund's shares.
While this makes money put into an interval fund an illiquid investment, it also makes it hard if not impossible for a bank run to develop in which panicky investors pull their money amid a big market rout, Terwillger says.
Interval-fund managers also have great freedom when it comes to putting money into illiquid investments such as real estate and corporate loans. While mutual funds can't have more than 15% of their portfolio in illiquid assets, interval funds don't operate under that cap.
Freed up to pursue the most profitable investments, interval funds can generate high returns and high distributions for investors, Terwillger says.
Reasons for Caution
However, there's also reason to be cautious about interval funds as well.
The Financial Industry Regulatory Authority notes that interval funds can be costly to invest in, with fees significantly higher than your typical ETF or even your mainstream open-end mutual fund.
Management fees can top 1.5%, service fees of up to 0.25%, and annual fees of over 3.5%. And the fund can take up to 2% of the proceeds during periodic share redemptions or buybacks, money that also comes out of the pockets of investors, according to FINRA.
Investors also need to be aware of the illiquid nature of money invested in an interval fund. If you need your money back quickly, you'll be out of luck, with the periodic share buybacks only enough to redeem a portion of what you've put into the fund.
There are other, traditional closed-end funds that can provide exposure to real estate, for example, that will provide greater liquidity and lower fees.
"A lot of these products are sold, not bought," says Stephen Vogel, an advisor with Corvus Capital Management in Nashville.
"If you are a commission-based investor, you are incentivized to sell them," he adds.
Worth a Look
Still, Terwillger, portfolio manager of the Resource Credit Income Fund, a closed-end interval fund, calls himself an "evangelist" for interval funds, and contends they are worth a serious look for investors.
The ability of interval funds to focus intensively on real estate and corporate loans opens up to retail investors areas typically the province of institutional investors and other big players.
"I like bonds and loans for the very simple reason they pay off at par," Terwillger says. "I like that return profile."
Their illiquid nature, along with the ability to borrow and use leverage -- another characteristic interval funds share with other closed-end funds -- could position interval funds to do some bargain hunting after a major market downturn, he says.
"When we go through the next cycle, and the monster bond funds are being forced to sell collateral, we will be able to play offense, we are not being stampeded by our own investors," Terwillger says.