Opportunity Zone Pitch Day - March 23rd
Trends In Interval Funds & Closed-End Funds, With Kim Flynn
Interval funds have seen incredible growth in the past five years, along with the growth in the broader alternatives industry.
Kim Flynn, managing director at XA Investments, joins the show to discuss the interval fund “success story,” plus the challenges and opportunities that sponsors are facing right now.
Watch On YouTube
- Details on Kim’s background in the industry, including her time at Nuveen where she helped develop over 40 closed-end funds.
- A “crash course” on closed-end funds, and what types of assets they typically hold.
- An overview of the interval fund space, and its eye-popping growth in the past several years.
- Kim’s insights on challenges and opportunities in the interval fund industry, including a need for comprehensive product education for advisors and investors.
- An overview of XA Investments, and the unique services that the firm offers.
- Kim’s three big predictions for the alternatives industry (including one insight that might surprise AltsDb listeners).
Featured On This Episode
- Interval Funds are a Fast-Growing Alternative Investment Vehicle (CAIA)
- Variant Investments – Official Website
Today’s Guest: Kim Flynn, XA Investments
About The Alternative Investment Podcast
The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.
Andy: Welcome to “The Alternative Investment Podcast.” I’m your host, Andy Hagans. And today we’re talking about closed-end funds, interval funds, a lot of unique and very popular products that are, frankly, have ballooned and grown very, very popular in this space in a pretty short amount of time. And joining me today is Kim Flynn, who is managing director at XA Investments. Kim, welcome to the show.
Kim: Thanks, Andy. Great to be here.
Andy: And you know what? We have a lot to talk about today, right? We’re talking alternatives, closed-end funds, interval funds. But before you came on to record, I was doing a little bit of reading up, you know, in preparation for this conversation. I’m aware of what you’re doing at XA Investments, but I also read about all the work you do at Nuveen. And you helped develop over 40 closed-end funds.
I was like, wow, we have to get this woman on our podcast to talk about closed-end funds and alts. But why don’t we start with that, because I think that’s pretty interesting that you were involved, you know, kind of early on in that space. Could you tell us a little bit more about your background and how you got started in finance?
Kim: Sure, sure. I was a member of Nuveen’s product development team for close to 12 years. And the entire time, I focused on launching new listed closed-end funds. And Nuveen is a market leader in the listed closed-end fund market, you know, really because of the municipal bond heritage that Nuveen is well-known for. And proud to be part of that team, and had the benefit of tremendous mentorship in developing these types of complex products.
And the work that we did at Nuveen, one thing that surprises people is that it was often in partnership with outside portfolio managers. So, when we didn’t have a capability or skill internally, we would look to partner externally. And when I left Nuveen in 2016, I launched an asset management platform as part of an investment bank here in Chicago, to do just that, to focus on alternatives, and to do it in partnership with sub-advisors.
And so we have a lot of dialogue with asset managers from very small boutiques to some of the largest wealth managers around the globe. And the reason for that is that these types of products, these closed-end funds, listed funds, interval funds, are really a very niche product category. So, people, they’re a bit of a mystery, and Nuveen is one of the firms that understands them well. There are a few other, a number of Chicago-based firms.
And so we shed a light on an area in the market that’s becoming very attractive, very interesting, because these structures house alternatives in a way that makes ’em accessible for anyone, unlike a private fund, where you might have to have some sort of suitability requirement, or meet some sort of suitability standard. So, these vehicles make alternatives more accessible.
Andy: Yeah, and it’s interesting you mentioned that they were kind of niche. So, I guess, trip down memory lane, I’m remembering, this was back in 2009, and my current business partners, we were then business partners in a previous business, ETF Database, so we were covering the ETF space. And that space, you know, it wasn’t like it was brand new, but it was still kind of in its younger days. And ETFs were kind of, you know, blowing up, really amassing assets.
And I remember, I didn’t even really know about closed-end funds, and I was like, what the heck are these? Like, why? What is this? And I… Like, at that time, I never even really answered that question. I guess I wasn’t curious enough, but for folks who aren’t invested in a closed-end funds, I guess, could you just big-picture, why is that product wrapper, why does that product structure needed? I mean, what’s the appeal? Why package a product as a closed-end fund, as opposed to a different product structure?
Kim: Sure. So, listed closed-end funds are often used by investors who are looking for income. And in the last 10 years, that search for yield has driven a lot of people to the listed closed-end fund space. Closed-end funds are just that. They’re closed to raising new capital.
So, once an initial public offering or an initial offering of shares is done, typically, the fund is closed and listed on an exchange like the New York Stock Exchange. So they do share some traits with ETFs, but ETFs have mechanisms, creation redemption units, that allow them to grow and to shrink. And…
Andy: So, an ETF isn’t gonna trade at a huge premium or a huge discount, right? Because otherwise there’s an arbitrage opportunity.
Kim: That’s right.
Andy: So, with a closed-end fund… Okay. Here’s another dumb question. Sorry to interrupt, but do they typically trade at a discount or premium, or has it changed over time?
Kim: It does. So, the interesting thing about listed closed-end funds is that the historical average discount is about 4.5%. And not surprising, closed-end funds used to be sold with loads that equaled 4.5%. So, that’s kind of funny, but…and the closed-end funds are sold largely in wirehouse firms initially, and then they migrate into other channels. A lot of investors pick them up at discounts in the secondary market.
And so, if you like income, and… There’s opportunities, there’s dislocation in the market. Right now, the listed market is a bit dislocated. So, the discounts are averaging eight-plus percent. So, that’s wide by historical standards. And then, even within that, there are particular funds, particular sectors, that are quite wide. So, just as an example, the 2021 IPOs, by and large, trade at 10% to 20% discounts.
So, on one hand, you know, if you were an IPO buyer, you’re not very happy. But if you’re a secondary market buyer, and the managers that come to market, that sponsor closed-end funds, are very high-quality managers. And so, you might otherwise buy the mutual fund, but that is trading at NAV. It’s not trading at a discount.
And so, savvy closed-end fund investors take advantage of some of those market windows or dislocations to add to positions that they already hold, or to establish a position in a new fund. Now, one of the main differences between a closed-end fund and the mutual fund is the use of leverage. And leverage is typical. It’s modest leverage, but it’s usually used with income enhancement in mind.
And so, for example, with the muni bond fund, you can pick up an additional 1% of income in return in a muni closed-end fund, compared with a muni mutual fund. So, that is, you know, terrific if you’re a muni investor. And that’s just one example of the advantage of the structure. There’s a number of other advantages that closed-end fund sponsors will tout. And so, we like to talk about some of those opportunities in the secondary market and some of the natural advantages that the structure has.
Andy: So, sounds to me, yeah, I’m thinking through. You said a lot that was really interesting to me, so there’s a lot to unpack. But my first thought is, okay, in this market, it might pay to be the secondary investor, right? Like, I’m… Because if you purchase the shares as a secondary investor, you’re not paying a load, right? Just might pay a trading execution fee, or the bid-ask spread or whatever, but…
And then another, you know, kind of a similar situation, maybe, is what’s going on with private REITs and publicly-traded REITs, where you referenced mutual funds trading at NAV. And I’m thinking, you know, private REITs, some of those will now have a NAV or be…they’ll do some sort of internal valuation or whatever, but then in the public markets, they might be owning not the exact same asset, but in some cases substantially similar assets, and the market’s hitting them with a 10%, 15%, 18% discount, or whatever.
And so that’s an example where you’d think as an investor, I’m always paying a premium for liquidity, but sometimes the liquidity will be a punishment, you know, for the more liquid version of that asset. Does that make any sense?
Kim: Yes, I think that can be the case, but I would divide the world into more liquid strategies, things that you typically find in, like, a traditional mutual fund or ETF, the underlying securities are liquid, and then bifurcate that with the illiquid or alternative investments. Because sometimes, with public vehicles that are comprised of illiquid alternatives, discounts develop for different reasons, due to valuation concerns.
And when the market reprices the way that it did in 2022, with the Fed raising rates, it has investors wondering, well, where is the risk-free rate going? And so if you’re reassessing every asset within your portfolio, including your illiquid alternatives in… And frankly, the rapid increase in interest rates led to, frankly, a rapid revaluation of the assets within those illiquid portfolios. So, necessarily, investors were questioning, like, what is the true NAV? What is the true value of these securities?
And by and large, listed closed-end funds have fairly liquid securities like mutual funds. So I think, when we talk about listed closed-end funds, the discounts develop typically because of supply/demand, right? So, certain funds fall out of favor, it’ll go to a discount. Sometimes there’s strategies that just are not working, the fund is not performing, and those discounts can become persistent. And that’s really a call for a fund sponsor to restructure a fund like that.
But I think you raise a good question about some of the non-traded REITs, the non-traded BDCs. Some of those vehicles, they’ve been in the headlines a lot, for the very reason you’re bringing that up.
Andy: So, zooming out, with closed-end funds, you know, you talked about these exist to provide investors with income. Like, that’s kind of the theme. And you mentioned that most of the underlying securities that they hold are liquid. So, what’s a typical closed-end fund, or are there, like, you know, are there major, very popular asset classes that they’re holding?
Kim: Yes. And I mentioned Nuveen’s heritage in municipal bonds. The origins of the listed closed-end fund market largely grew out of the funds that Nuveen and BlackRock and others raised that were municipal bond funds. And the reason that investors liked those funds so much is that you could add leverage to a muni bond portfolio, and enhance yields, and that benefited bond holders. And so…
Andy: Well, Kim, I’m just thinking, that’s funny that you bring that up though, because I’m thinking, okay, I’m in this Vanguard Muni bond fund, and I know it’s different now, but most of the time I’ve been in this fund, and it’s, like, a short-to-intermediate, the yield has been, like, 1.6%, or just something like, not…even when inflation was low, it wasn’t anywhere near the inflation rate. And I’m thinking, how can funds layer on any expense structure whatsoever to justify itself when the gross yield is, like, 1.6%? But maybe the answer is leverage. So, is that enhancing the gross yield?
Kim: Yeah, absolutely. So, there’s a number of things you can do in the muni space. It’s one of the reasons why high-yield municipal bonds, unrated municipal bonds, you can pick up additional yield that way. You know, municipal credits are viewed as fairly safe.
There have been very few defaults in the municipal bond market. And so, in some ways, people are willing to go into below-investment-grade or unrated municipal bonds, because they have confidence that those municipalities will be backed up by state and federal bailouts if that was ever necessary. And we’ve observed that in the history.
So, absolutely. I mean, frankly, municipal bonds kind of lend themselves to that. But, in addition to munis, you have categories like senior loans, which are floating-rate investments. In an environment like right now, a lot of advisors are looking at floating-rate loans. And they lend themselves to use of floating-rate leverage. So, there’s a natural arb built in, if the assets and the liabilities in the form of leverage are floating.
So, there’s a lot of reasons that investors, while not well-understood, the closed-end fund market is really interesting for investors who are looking for some of these opportunities. And so, we do find a lot of… If people know about the listed closed-end fund market, they tend to buy funds in several different sectors and several different categories, because they catch on to some of these advantages.
Andy: Interesting. So, it might be, you know, I want an allocation to municipal bonds, and then I might realize, compared to the index fund, or actually, it’s an actively managed. Compared to the actively-managed mutual fund that I own, I could get a closed-end fund that, number one, might be trading at a discount right now, and number two, might be using leverage to enhance the yield. Is that basically the logic that I’d be using?
Kim: That’s right. And right now, you know, you can look at a number of Nuveen funds. Many of them are trading at discounts. I think part of the reason that’s driving some of the concern is with rates moving higher, people are concerned about the sustainability of the distribution payments, right? And so, you do have dislocation in the muni market right now. I think a lot of interesting opportunities in that marketplace. And the one benefit of the listed closed-end fund market today, that didn’t exist years ago, is that the funds are now offered on a no-load basis. So, any new IPO is done no-load.
Andy: Okay. So, that’s a change. Wow. Just the constant cost pressure in our industry, right, is good, ultimately, for investors. So, that’s…Yeah. So, at Nuveen, you helped develop over 40 closed-end funds, raising this literally billions of dollars in capital. But during that time, you’ve already kind of referenced, there’s so much changed because… I believe you worked there, what, 11 years. So, during that period, you know, how did the industry shift? It sounds like maybe the cost structure went a little lower. Were there any other changes in the closed-end fund market?
Kim: Well, I think the one thing that’s happened in that marketplace is it’s become fairly saturated. And so, there was a rapid expansion of the listed closed-end fund market into new asset classes, new strategies, new sectors. And that was really from the beginning of 2000 until sort of 2015. And in 2015, we saw a lot of energy MLP funds come to market. And given the history in that marketplace, obviously quite volatile. So, I think that led to a pause in the issuance of new closed-end fund IPOs.
Now, one of the things that some of the fund sponsors did was they started looking at opportunities to launch non-listed closed-end funds. And so, in that category, you’ve got interval funds, tender offer funds. It’s just a different type of closed-ended structure, but it’s being used now for alternative strategies. And even though I said they’re a type of closed-end fund, interval funds and tender funds are actually continuously offered. So, effectively, they’re open-ended and they can grow over time.
And so that’s really the shift that we’ve seen in the market in the last five years, is much more focus and attention on the interval fund space.
Andy: And so that brings me to your current firm, XA Investments. For those in our audience who aren’t yet familiar, could you tell us a little bit about XA Investments and your role there?
Kim: Sure. I’m one of the founders in the business, and we set up the practice where, because we do not have in-house wealth management, we partner externally with asset managers. We either hire firms as sub-advisors… We launched our first listed closed-end fund about five years ago, in partnership with an external sub-advisor. It’s an alternative credit strategy.
And then, in that work, partnering with asset managers, we would have discussions about the types of products that they would be interested in launching. And that has led us to develop a consulting practice. It’s very much the same work that we do in launching our own funds, but now we help asset managers launch funds for their proprietary platforms.
We have been responsible for helping new fund sponsors enter the listed closed-end fund market. We also advise asset managers in the US about raising capital in the London listed market. But I would say most of our clients are curious and most interested in the growing interval fund space. So that’s a lot of where we spend our time.
Andy: Yeah. And I think it’s fair to say that you’re an, a kind of a go-to expert on interval funds. You did a really good job explaining closed-end funds and their appeal to investors and where they kind of fit. So, I’m gonna get greedy, and now I’m gonna ask you to do the same thing. Walk us through interval funds, walk us through tender offer funds, you know… What are the differences between a normal, typical closed-end funds and these other product structures?
Kim: Sure. So, it may surprise people to learn that the closed-ended fund structure, so, it’s a type of ’40 Act product, like the mutual fund is also a ’40 Act product. Closed-end funds are distinguished…and I think one of the categories of closed-end funds that your listeners may be familiar with are BDCs. Business development companies are a type of closed-end fund. As are interval funds. They’re also a type of closed-end fund.
And so, let’s contrast the closed-end fund with a daily liquid mutual fund, where investors can get in and out at NAV on a daily basis. Most of the closed-end funds have different mechanisms for shareholder liquidity. And so, taking the interval fund as an example, you could invest on a daily basis, to the extent that that fund has a daily NAV. But the exit is typically gated or limited to 5% a quarter.
And so, that’s what allows those funds to invest more heavily in illiquid securities, and frankly, generate attractive total returns in some of these assets that require a longer investment hold period. And so, interval funds, right now, house real estate, credit, private equity, venture capital. There’s a number of fund-of-funds, like endowment-style funds. But, you name it. If it can be put into a private fund, it’s now being repackaged in this interval closed-end structure.
Andy: And because it’s not as liquid… It’s still, it’s somewhat liquid, compared to many traditional illiquid private equity funds. But because it’s limited liquidity or intermittent liquidity, or whatever word you wanna use, an interval fund has more freedom to really own almost anything, right? You know, any kind of alternative asset, versus to closed-end funds, which, your point earlier, tend to own those more liquid underlying assets. Is that…?
Kim: Yeah, you know, the legal closed-end fund structure would allow any closed-end fund, whether it’s listed or interval, to have 100% in illiquid securities. But practically speaking, listed closed-end funds don’t do that, because most of them have a daily NAV. And if, for example, you put an illiquid investment that cannot be valued daily, a large discount presumably would develop, because people are questioning the value of the assets within the portfolio.
So, listed closed-end funds typically have daily NAV, and they typically have more liquid portfolios, because of the way…it’s an underwriting process, and it’s really more about the way they’re sold. Now, we talked about interval funds. They, too, could have up to 100% in illiquid assets, legally speaking, but liquidity management, and having a liquidity plan to make sure that you’re meeting the quarterly redemption requests, is really fundamental.
And I think that some of the concerns that we saw expressed in Q4 of last year, when people are prorated on liquidity, it’s frustrating. And so, it’s really important… Not just frustrating, but worrisome, to the extent that you may not be able to get out in a given quarter, or maybe even the next quarter. And so it really raises the question of what are fund sponsors doing on the front end to help people understand inappropriate investment horizon, and really the liquidity constraints that are there?
I do find that as we observe industry participants, a lot of them gloss over, and they frankly oversell the liquidity of an interval fund. These are not mutual funds, and they should not be sold in that fashion. And so, that does worry me, as an observer of the market, because, you know, if someone doesn’t understand the fact that the prorations can happen for one quarter or multiple quarters, you know, in reality, the market hasn’t been tested just yet.
A lot of these vehicles were not sized or scaled, if you go back to ’08, ’09, in the Great Financial Crisis, we were talking two years, a long period of time, where, in theory, if you had funds like this, that were quarterly tenders, you’d be prorata’d for multiple quarters, right? And so, I think that we need to be careful, we need to be thoughtful, and make sure we understand how these vehicles should be used. Now, you know, you don’t need 100% of your portfolio sitting in mutual funds and ETFs. There is a spot for these. But the liquidity difference should be understood.
Andy: Yeah, I mean, I agree 100%. And, you know, I love alts. I hope I would, if I’m hosting “The Alternative Investment Podcast,” and I love innovation in the space. But, you know, sometimes innovation, sometimes change can be a little clunky, let’s say, like, you know, like, some really good things will happen, but then whenever there’s change, sometimes there are unanticipated, or not even necessarily anything nefarious, but just sometimes there are side effects that folks aren’t anticipating.
One thought that I’ve had about these interval funds is, you know, in the publicly-traded REIT sector, these assets are getting re-priced in real time. And I’ve heard the point that, you know, Mr. Market is manic, and maybe some of these REITs are being too heavily discounted. And I think I agree with that. I think that’s, like, a fair point.
But at the same time, when I think, okay, but a NAV for a non-traded REIT and a publicly-traded REIT, if they’re just not being calculated in the same way, if they’re not being calibrated in the same way, that’s a problem just for me as an investor or for me as a family office. It’s just kind of like an apples-to-apples problem. Like, I’m not…
And then I’m thinking about, okay, now take an interval fund. This is actually what bothers me is, if I’m in an illiquid investment, or if I’m in a REIT, I can sell my REIT that day. If I’m in an illiquid investment, like, I’m an LP in some Opportunity Zone funds, that’s a 10-year hold. And I know going in, this is a 10-year hold. With intermittent liquidity, with interval funds, different investors can get in and out at different times. Fine. That’s just like a publicly-traded REIT. Different investors can buy in and get out at different times at different prices.
But the issue with the interval fund, to me, is that the value, if it’s this NAV, if it’s being calculated internally, or however those are calculated, now, if there’s a little bit of a stampede for the exits, or whatever, let’s say I’m just holding. I bought this interval fund or this intermittent liquidity product, and, like, I don’t need the liquidity now. But, if there’s a stampede, it’s probably a sign that maybe the NAV is a little too optimistic. But the folks that are cashing out this quarter, they’re cashing out of this higher NAV, right? At this higher NAV, and now I’m gonna be stuck. But what happened is cash exited at that higher valuation, and it’s almost like the folks that remain in the fund, are we not worse off as a result of how that NAV is calculated?
Kim: Yeah, you very well could be. And the same is true in some ways for mutual funds, the difference being you might question the valuation of an illiquid portfolio even more, but when you’re a forced seller, even in public securities, you know, in a March of 2020, or if you’re a forced seller in 2022, you’re gonna be realizing losses that you otherwise wouldn’t have done so. So, yeah, I think both structures… One of the things that you’re pointing out is the listed closed-end fund is not a forced seller, and they’re not gonna suffer from that. If you want out, you get out through selling your shares on the exchange. So, only you take the hit, not the portfolio. The portfolio is protected. So, as a longtime builder of listed closed-end funds, in my opinion, that is the ultimate vehicle to hold illiquid alternatives.
And so that’s why I’m sorry that many of them are not more illiquid. Many of them don’t house alternatives, because it is the right structure, for the reason you’re pointing out. And so, I think you made a good point about people questioning value, and they should question, not just because they might be doing valuations internally, as opposed to using a third-party valuation agent. One thing…
Andy: When I say “internal,” I might even be, I’m sort of fudging it. I might even mean “third-party agent.” But the point is, it’s not manic Mr. Market, right? It’s not being repriced by the wisdom of the crowd. And we know the crowd’s not always wise. But at least it’s kind of democratic, I guess, is my point. Go on.
Kim: Yeah. No, and I think that’s fair. The only assurance I would offer about valuation is that the trend is that third-party valuation firms, which specialize, you know, you got specialists in real estate, specialists in farmland, specialists in credit. And there are good third-party valuation agents that are providing daily marks.
Now, some of them use matrices, some of them use algorithms, some of them have different method, but part of it is what are they’re feeding into their evaluation model is partly coming from public markets, which is good, right? That informs how they should be marking those assets. Maybe not all the way, right? Because it’s like, you have a choice when you sell a building or when you sell your home. You’re not gonna sell it. And so, that really, I think you’re making good point. Like, we don’t want portfolio managers to be forced sellers, and to take those prices…
Andy: And Kim, yeah, here’s the thing. I don’t want anybody to think I’m beating up on interval funds or NAV REITs. Like, a lot of these products, the kind of 2.0 next-gen versions of them are awesome. And I love the innovation that’s going on. But even the very good, high-quality third-party folks doing the valuation, to me, it’s not about how smart you are or your computer model. They’re smarter than me, and they have better computer models than I do. But, it’s skin in the game.
Because at least manic Mr. Market, the folks buying and selling publicly-traded REITs, they’re voting with their own dollars. So, if I’m gonna get a third-party valuation of BREIT, are you a buyer at that price, with your own money? That’s kind of what I’m getting at. Because if you’re not, I’m gonna take it with a huge grain of salt if you’re not actually putting your own money behind it, if you’re not voting with your own skin in the game.
Kim: Yeah, it’s a fair question, and I think that’s why Blackstone and others have come out and published how much of, you know, management capital is invested in the vehicle, because they are very well-aligned, right? In terms of kind of riding the ship, and they’re a believer in those assets. So, I think that does help.
But, in terms of these vehicles, one of the concerns that I have is sometimes things get so big. So, one of the things I’ve talked about is the velocity of money coming into a fund that is that large. You have to expect the velocity of the money coming in would also, when things turn, the velocity of the money coming out would be equal…it might be greater. But if you’re daily-in, quarterly-out, subject to prorata, you’re setting yourself up for… So, I tend to like some of the fund sponsors who have caps in place, who are scaling at what I think is an appropriate rate. And so, you know, you do question sometimes, with the size and scale, or sometimes with how quickly the money comes in. So, yeah, I wonder about a lot of those things myself.
Andy: You mean, like… So, sorry. Just to parse that a minute.
Andy: If it’s coming in more quickly than 5% a quarter, is that kind of what you’re saying? Because it’s like, we should expect it to go out at the same rate it goes in, so if it’s going in more than 5% a quarter, then we know that it’s gonna get prorata’d at some point.
Kim: That’s my worry. And I think some of the fund sponsors in the interval fund space are very disciplined. They treat the funds like quasi-institutional funds, private funds. They manage the dialogue and relationships with… And they’re not taking everybody’s money. They actually turn people away if they don’t understand the liquidity limits, you know? So, in some ways, they’re on the front end, putting up a barrier which protects them on the back end.
So, it also deters sales, but it means they’re getting the right long-term investors as partners, and they’re gonna scale differently. And so that’s, I think, a responsible way to manage a portfolio like that. I’ll refer to a fund that’s now closed, which was the endowment fund that was very popular. The endowment fund was sold into the wirehouse firms.
And in the Great Financial Crisis, basically, there was a run on the bank. They had navigated the market crisis in ’08, ’09, and then there were a lot of requests for redemptions, and the fund sponsor decided to close the doors and not let people exit. And it resulted in sort of a death spiral of the fund. And so, I think managing people’s liquidity expectations on the front end, having the right asset mix and liquidity plan, is critical to the success of these vehicles over a long period of time.
And I do wonder if there’s something about, you know, having a more moderate pace of growth, but clearly… So, I think there are some lessons to be learned from the recent questioning. I think it’s a healthy thing for the market.
Andy: Absolutely. No, I appreciate all those points. I’m just so glad we have had you on the show because there’s a lot going on with interval funds that, people just need to understand them. Because with all these product structures, closed-end funds, interval funds, you know, I referenced qualified opportunity funds. Those have a 10-year hold. There’s no problem with a 10-year hold. I know going in, I’m writing this check. This is a 10-year hold, period.
As long as I understand that as an investor. As long as, you know, if I’m a qualified purchaser or accredited investor or family office, if it’s appropriate for my time horizon and all that, it’s fine. But the education is really what’s important, so that, you know, the right investors are getting into the product, and they understand it, and the advisors understand it.
So, you kind of alluded to… And it’s interesting. I could also make the counter-argument and say, you know, these are the next-gen versions of a lot of these products with interval funds. These are something pretty new. And I think there’s another argument to be made, to say they’re holding up pretty well. You know, like, there’s been a lot of stress in the past 12 months. And I don’t really get the sign that anyone is panicking, including investors, you know, even some that maybe want their liquidity.
But what would you say, I guess, if you’re looking at interval funds, what are the best practices? You know, if you’re designing a product that’s gonna launch the second half of 2023, what would you really point to and say, these are the things that the best interval funds are doing really, really well? Not necessarily the biggest funds, but the ones that are well-designed, that are serving their investors. What should I…both the terms of the product, the assets it holds, and also maybe how it’s marketed, and the education piece?
Kim: Sure. There are a lot of new entrants to the interval fund market, so it is attracting a lot of attention. And, you know, there’s a lot of boutiques in the mix, too. It’s not the biggest mutual fund sponsor. So, in that sense, I think that we’re in the early days of the development of the market. One thing that happened this year, in 2022, is that I believe we have proof of concepts now, because there are 30 interval funds that are north of a billion dollars in size and scale. And so a lot of, you know, sophisticated alternative managers, they’re not gonna get out of bed for less than a billion dollars. But now that you…
Andy: I know I don’t, Kim. I don’t know about you. I don’t get out of bed for less than a billion dollars. I mean, come on.
Kim: Hey, I’d be happy to run a $500 million-sized fund. But no, we’ve heard that too. And it’s like, “Oh, I only want $1 billion. I only want $5 billion.” But I think what they’re saying is they want evergreen structure… From the fund sponsor perspective, they want a vehicle that they can grow over time. And that’s what you see of the biggest, the Blackstones, the BlackRocks, the Apollos, the Aries, they want these semi-permanent capital vehicles.
And then, I think the things that are done well, or when sponsors launch the right way, is many of them are launching with seed capital or lead capital, or even private funds that get contributed. Investors don’t wanna go into a small, subscale fund. And so, in addition to bringing that capital to launch the fund, we’re also seeing expense waivers. We’re seeing management fee waivers.
And it’s meant to make these funds more attractive, because when they do scale to $500 million, or they do scale to a billion, from a fee and expense ratio, you know, that’s gonna look, optically, it’s gonna be a better look than it is early on. And so, you have to do that. And it’s a big commitment, a big financial commitment, to scale a fund like this. So, the fund sponsors that we think go about it the wrong way, you know, you have to start with the client in mind, with the RIA in mind, and that’s really the heart of this market. You know, you can’t go into another channel, like the wirehouse channel, until much later, until the fund is scaled. But some of those firms that I mentioned, that have best practices, Variant is a fantastic firm, and they are dedicated to the RIA space, and they’ve been true to that, and they’ve been able to scale their funds. So, I like to see that.
The fund sponsors that I think make a mistake, it, oftentimes they kind of just quickly get on file with the SEC, and they haven’t sorted through what the client wants, and how they’re gonna be able to compete or… The market’s now grown to 180-plus funds. So, particularly if you’re a credit fund sponsor, you know, there’s a lot of credit funds. So, you’ve gotta be thinking about how am I gonna compete with the existing funds? How am I gonna have some sort of edge or advantage? So, we work with a lot of our clients about that approach.
But I still think, you know, you mentioned education. The buyer base for these funds initially is largely RIAs, but it’s still fairly concentrated. You know, it was the RIA that understood real estate, or that had been buying BDCs, and so they were much more comfortable with alternatives.
Andy: The RIA that’s already listening to this podcast, right?
Andy: The subset that’s interested in alts that already invests in alts.
Kim: But it’s their friends that may not yet, and don’t have the comfort. I think a lot of advisors, you know, because they’ve been investing in the REIT market, the BDC market, for the last 20 years, and they liked them because they were income vehicles. They also had some additional total return. And so, the interval fund market has grown out of that, but I do think we need to see an expansion in the buyer base, because the buyer base is not expanding as quickly as the products are proliferating.
Andy: Interesting. Yeah. And that puts pressure, I guess, on people in a variety of ways. So, it’s an interesting prediction. You know, it’s a theme that kind of comes up again and again. Literally, I think almost every guest, Kim, I think this is, like, episode 90 something. I don’t know if it’s 92, 93, something like that. And almost every single episode of this show, it’s a topic that comes up, is the need for more education. Because there are so many different products, strategies, asset classes in alternative investments.
I mean, I’m hosting this show, right? Like, recently, I had a couple guests on. We’re talking about hedge funds. I’m like, I know what a hedge fund is, but then within hedge funds, there’s all kinds of different hedge funds. And one hedge fund has almost no resemblance to another, maybe aside from the fee structure or something.
And if you’re an RIA, you know, how much of your time, realistically, can you devote to understanding the ins and outs of every single product? Like, we have to be realistic, right? So, I think you coming on and just… I definitely appreciate your integrity, your honesty, just your transparency about all of this, because I think it’s so helpful to just kind of get that third-party objective perspective.
And now, zooming out a little bit, because we’ve really talked a lot about interval funds, I know you work with a variety of different companies, different managers in your role, which gives you that unique vantage point. Are there any other trends that you see playing out in the next couple years in the alternatives industry that might be flying below the radar, can we say?
Kim: Yeah, three trends that we’re starting, that I think are emerging trends. One is the RIA, the wealth manager, who has become acquainted with interval funds and says, “Hey, I’m gonna launch my own. You know, I’m gonna build my own proprietary interval fund because I’m the one with the relationship with the client.” And so, that’s interesting. And we’re seeing a number of those get on file.
So, you know, in some sense, now, the RIA, with a proprietary fund, is gonna compete. Is gonna compete with the existing managers. But instead of allocating to those competitors, they’re gonna develop something, I think… And so, I think we’re gonna see more RIAs set up shop and launch their own interval funds.
One thing that’s similar is the direct-to-consumer, the FinTech platforms. We have seen the success of firms like Fundrise, and others, with multiple interval fund launches, because they too, they’re saying, “Hey, I have the client relationship, and I’m gonna build a proprietary fund. I’m not gonna just allocate to these alt managers. I’m gonna build my own.”
So, that, that one is a little bit further ahead. We’ve got 10 or so direct-to-consumer FinTech platforms. And it’s too early to tell. Fundrise has raised a fair amount of capital, which is impressive. Now, the others are early. It’s early days to determine, you know…
Andy: And those are… I guess that difference is that they’re targeted to non-accredited investors? They’re kind of the crowdfunding…
Kim: Yeah. Some of them are non-accredited, some of them are accredited, just because the accreditation standard is fairly low. But, you know, I think that it’s something because, you know, instead of keeping part of the fee, they’re saying, okay, well I’m gonna take 100% of the fee, because the most important thing is the fact that I wanna make the investment decision, and this is my client relationship. So, that’s really interesting.
The third trend that is still sort of newer, and frankly, there’s been some ESG backlash, I think, in the U.S., maybe more so than in Europe, but we have seen five impact funds launched. So, these are, you know, private asset funds, which I think is really interesting, and might be more compelling for U.S. investors than, like, an ESG index ETF, which we’ve seen a lot of mutual fund and ETF product that have been labeled as ESG products.
But because of these impact-oriented interval funds are investing in alternative or illiquid securities, you’re gonna get a different return profile. So, I think that might be of interest to some investors.
Andy: Well, those are all really interesting trends. Yeah, I mean, ESG, it is a little bit of a charged word, shall we say. And I guess my two cents is it can mean different things to different people. And, you know, different managers might have a different viewpoint of what a desirable ESG goal is. And so, you know, when you take it into that active managed space, versus a bunch of funds that are all following the same two or three indexes, you’re gonna get more variety and more choice, which, as far as I’m concerned, that’s always a good thing for investors is to have more choice.
So, Kim, I can’t thank you enough for coming on the show today, sharing your insights. Again, I love just your transparency and honesty about this space. So, I’m guessing a lot of our listenership of financial professionals, I know we have some industry folks who are listening, might wanna learn more about your services, about XA Investments. So, where can our listeners go to learn more about your company and the services it offers?
Kim: Sure. So, you can go to our website at xainvestments.com, or, you know, if you’re in Chicago, look me up on LinkedIn, and would love to meet you in person, or, you know, happy to help. We do a lot of client reporting for people who are just curious about the space, too. So, we probably take 15 calls for every single new client that we bring on. And that’s just because there’s so many asset managers exploring this space and trying to get up the learning curve on these new product structures. So, we’re always happy to help, Andy.
Andy: Absolutely. So, for you asset managers out there, I’ll make sure to link to all this stuff in our show notes, which are always available at altsdb.com/podcast. Kim, thanks again for coming on the show today.
Kim: Thanks, Andy.