What Is an Interval Fund?

Jerome Cesarz is a senior investment consultant for Northwestern Mutual.

For years, income-oriented investors have struggled to find opportunities. A select group wants to go beyond the basics of investing and find more sophisticated financial tools.

As Treasury bond yields neared historic lows over the past decade and a half, it became harder to generate income from what had been a traditionally safer asset class. While equities offer potential for price appreciation and dividend payments, they’re also volatile and risky—maybe too risky for someone seeking steady, reliable income from their portfolio. Whether you invest in a mutual fund, exchange-traded fund (ETF) or individual stocks and bonds, the predicament is similar.

Fortunately, the financial industry has a knack for meeting niche investor needs. One solution, launched in the 1990s, is the so-called interval fund. An interval fund is a type of closed-end fund. Instead of trading on the open market, these funds allow investors to periodically redeem shares at preset intervals (usually quarterly).

• The funds typically invest in illiquid or alternative assets that require a longer investment horizon.
• They can provide access to a higher-yielding portfolio of assets that may not be available via a mutual fund or ETF.
• Interval funds are gaining in popularity. An average of 12 new funds launched every year since 2017. This year is expected to produce the largest number of new funds yet.¹

Here you’ll learn what interval funds are and what makes them unique.

It’s all about liquidity

To understand the distinctive features of an interval fund, we need to briefly dig into the mechanics of markets. Mutual funds and ETFs are open-end funds, and investors can buy and sell them any day the market is open. ETFs and mutual funds are highly liquid, meaning they can be bought and sold relatively easily.

Let’s start with a simplified example. When you purchase $100 of an ETF, the fund manager purchases that amount of all the assets that make up that fund. When you sell $100, the fund manager sells $100 worth of its underlying assets. This works well for an equity ETF because all the stocks in that fund are easily bought and sold on major exchanges. But these mechanics don’t work for assets that can’t be bought and sold very easily—they’re illiquid.

Basically, if you bought or sold $100 worth of a fund holding illiquid assets, fund managers would have a hard time buying or selling the same amount of the fund’s underlying holdings. Therefore, ETFs and mutual funds are prohibited from having a high percentage of illiquid assets, such as certain high-yield bonds, bank loans, private debt, structured products and real estate.

But these types of investments have the potential to generate higher yields and long-term returns. And you can invest in them with an interval fund.

They’re not for frequent traders

Interval funds give investors access to those higher-yielding alternative assets because the funds aren’t bought and sold like other funds. Each day, the funds are priced based on the net asset value of all the fund’s holdings (that’s the price you’ll pay per share). While you can buy most interval funds on any given day, you can’t sell them whenever you choose.

Instead, interval fund managers periodically offer to buy back a predetermined percentage of the fund’s outstanding shares every three, six or 12 months. Most buy back on a quarterly basis. You must decide in advance to have your shares redeemed before the next buyback period. And if the redemption limit is reached, there’s no guarantee you’ll be able to sell all the shares you want to.

Essentially, you are giving up the ability to sell your shares easily in exchange for access to higher-yielding, alternative assets that were once available only to institutions and hedge funds. This could be considered one of the major disadvantages of interval funds. On the other side of the table, limiting redemptions allows fund managers to package these illiquid assets into funds.

Interval funds have higher fees than other types of funds

In exchange for higher yields, investors also will typically pay higher fees. Interval funds require a hands-on approach from managers. They might be on the phones buying derivatives or private debt offerings or purchasing bonds that don’t trade on an exchange. So, you’ll find that an interval fund’s expense ratio, which is an annual charge that covers management fees and operating costs, is high compared to open-end funds. In fact, the expense ratio of an ETF or mutual fund are commonly in the tenths of a percent, while interval funds can be in the low single digits.

Another reason fees are higher is that funds rely on third-party providers to value the portfolio’s holdings. Since those are typically private securities, pricing takes a little more work, and that leads to higher costs.

Interval funds can have high minimum investments

You can buy into an ETF or mutual fund for as little as a few hundred dollars. But you may need to initially invest $25,000 or more to purchase shares of an interval fund. While this is significantly lower than the $250,000–$25 million initial investment required for private security products, it’s a lot of money for most people. So, that’s one of the disadvantages of interval funds.

Interval funds are a long-term investment strategy

Because these funds can’t be sold easily, interval funds are a better fit for investors who want to leave money for a relatively long time. That discourages trading too frequently or trying to time the market, which is often detrimental to long-term returns.

Interval funds can lower a portfolio’s volatility

These funds aren’t traded on exchanges, and the underlying assets have lower correlations to their publicly traded counterparts. That can help lower overall portfolio risk. But there’s no evidence to suggest that interval funds, on their own, are any less volatile than corresponding mutual funds or ETFs. However, in a well-diversified portfolio, interval funds can help the right investors get access to assets with less correlation to assets traded on the broader market. Everyone’s financial picture is different, and there’s no “ideal” investor for an interval fund.

Interval funds offer a lot of opportunity

Interval funds, on average, have the potential to provide higher yields and returns than mutual funds or ETFs. That’s because they can invest in both public and private assets, giving them a wider universe of investment opportunities.

We’re not saying that this expanded opportunity guarantees high performance. And remember that fees are higher, which affects your profit potential.

See the larger picture

Your Northwestern Mutual financial advisor will ask deep questions to get to know you and what’s important to you. Together, you can talk through your strategy—including ways to grow and protect your money.

No investment strategy can guarantee a profit or protect against loss. An investment in an interval fund is not suitable for all investors. Unlike an investment in a traditional listed closed-end fund, interval funds should be considered illiquid. Investors should consider their investment goals, time horizon and risk tolerance before investing.