Interval funds are a special type of mutual fund that offers investors an alternative channel to achieve their investment goals.

They’re generally targeted toward higher net-worth individuals with minimum investment requirements, usually starting from £10,000. However, the fund manager has much more freedom regarding which financial instruments they can use to deliver superior returns than a regular mutual fund.

What is an interval fund? 

An interval fund is a closed-end mutual fund that periodically buys back its own shares from investors at predetermined times during the year. Typically, the intervals are once every quarter. But there is no definitive ruling, and it ultimately depends on the fund manager.

The exact repurchase interval is declared inside the fund’s prospectus. And at every interval, an optional repurchase offer will be issued to shareholders.

Unlike a traditional closed-end fund which uses investor money raised during an initial public offering (IPO), shares of an interval fund are constantly being sold by the investment company running it. This means investors can purchase shares anytime, similar to how an open-end fund works.

How do interval funds work?

The share price of an interval fund is based on the net asset value (NAV) of its portfolio, which is updated daily. Like any fund, the investment manager takes shareholder capital and invests it into a diversified pool of assets such as stocks, bonds, commodities, derivatives, as well as private equity. Shareholders have a claim to the portfolio as well as any earnings or dividends generated.

The main difference arises when it comes to selling shares. Interval funds do not trade on a secondary market. As such, shares can only be sold back to the investment company that issued them. And this can only be done during the repurchasing events at a specified fixed interval.

When a fund repurchases shares, there is a limit on how much it can buy. The limit is typically around 5% of the total number of shares outstanding. However, some funds repurchase more, going up to 25% at a time.

Furthermore, the repurchasing of interval fund shares is executed pro rata. What does this mean?

Suppose a large portion of an interval fund’s investors decides to sell out, flagging their shares for repurchasing at the next interval. And consequently, the total number of flagged shares is higher than the specific repurchase limit. In that case, the number of shares repurchased from each investor will be equal up until the fund limit has been reached.

Therefore, even if an investor wants to sell their entire position, they may not be able to in a single transaction. And it could take several intervals before their stake can be sold entirely.

This makes an interval fund a largely illiquid financial instrument only suitable for long-term investors.

The differences versus mutual funds and ETFs

Interval funds are legally categorised as closed-end funds. Yet they also share characteristics with open-end funds.

They can sell their shares continually to investors without requiring them to go through an IPO. But also, don’t trade on a secondary exchange. And that makes them quite different from other fund types.

• Exchange-traded fund (ETF) – These are traded on stock exchanges like the London Stock Exchange or New York Stock Exchange. ETFs can be bought and sold like regular stocks and are highly liquid. But they are also more susceptible to volatility. Interval funds are less liquid but provide greater short-term stability.
• Mutual Fund – An interval fund typically contains more long-term illiquid assets than a regular mutual fund. Moreover, shares of a standard mutual fund can be sold at the end of each trading day when the stock market is open, giving them far more liquidity. By comparison, shares of an interval fund can only be sold at fixed intervals.

What are the advantages of an interval fund?

The illiquid nature of interval funds gives the fund manager greater financial flexibility over which assets and instruments they can use. This can lead to higher returns as well as improved portfolio stability.

• Higher returns – Without as much shareholder redemption pressure, the portfolio manager can leave the capital to work for longer periods. This provides a far better environment for compounding to amplify investor capital.
• Asset diversity – Because share repurchases occur at specific intervals, the fund manager can choose financial assets that mature in line with this timeline. This opens the door to alternative investments and asset classes like real estate, consumer loans, infrastructure projects, private equity, and private debt securities that regular mutual funds cannot capitalise on.
• Portfolio stability – Because shares can only be sold at fixed intervals and there are limits on how many shares can be sold at any one time, interval funds are notoriously stable. They are far less susceptible to emotionally-driven price declines of panicking investors.

What are the disadvantages of an interval fund?

Like any investment, interval funds have their own risks and drawbacks that investors need to consider.

• Illiquidity – Because of the repurchasing intervals, shareholders cannot sell shares whenever they want and have to wait until a repurchasing event comes due. Moreover, the limits on how many shares can be repurchased at each interval and the pro-rata execution can make it difficult to liquidate larger holdings. As such, it could take a long time to close out of a position completely.
• Higher fees – Like any actively managed fund, interval funds charge higher management fees each year. These costs vary between funds. But typically lies between 3% and 6%, which is significantly higher than alternative funds. By comparison, an index ETF normally only charges around 0.07% annually.
• Higher barrier to entry – Interval funds are financial instruments designed for more sophisticated investors with higher net worth. As such, they often require a minimum investment ranging from £10,000 to £20,000. This can place them out of reach for most retail investors.
• Opaque investment portfolio – Interval funds have the freedom to invest in more opaque asset classes like real estate and private equity. This can make it more challenging for average investors to understand what they are actually investing in.

Are interval funds a good investment?

Interval funds are another type of investment vehicle that can grant exposure to more obscure asset classes that aren’t easily accessible to a retail investor. This can significantly improve the diversification of a portfolio. And with the fund manager making all the decisions, investors can leave all the important decision-making to a professional.

However, these funds are also illiquid and can charge some fairly substantial annual management fees. While the performance of interval funds does tend to compensate for this, there is never a guarantee.

Whether interval funds are a good investment ultimately depends on the individual’s risk tolerance, time horizon, and investment objectives.

The bottom line

The interval fund structure provides a lot of desirable traits for investors who can afford the minimum investment requirements. However, they are inherently designed for more extended holding periods making them unsuitable for traders or short-term investors.

Their ability to tap into more unique asset classes also provides greater potential for returns compared to standard mutual funds. However, this also comes with increased risk. Given the more complex nature of this type of investment vehicle, it may be prudent to consult with an independent financial advisor before committing any capital.

This article contains general educational information only. It does not take into account the personal financial situation of the reader. Before committing to any investment decision, an investor must consider their individual financial circumstances and reach out to an independent financial advisor if necessary.

Prosper Ambaka does not have a position in any of the financial instruments mentioned in this article. The Money Cog does not have a position in any of the financial instruments mentioned in this article.