How Do Interval Funds Work?

Growing interval funds are bucking the trend of outflows from most actively managed strategies. Interest is surging as everyday investors look for yield in illiquid assets.

But interval funds’ complex structure may be new to investors and their advisors. Do interval funds have a role in a diversified portfolio, or are they just an expensive, unnecessary complication?

Here’s how today’s interval funds work.

For more in-depth exploration, download the complete interval funds guide.

While they make up only a small fraction of managed products, interval fund assets under management have grown almost 40% per year over the past 10 years through April 2024.

This investment vehicle blends features of open- and closed-end funds, creating unique benefits and risks for interval funds. By limiting how often investors withdraw money, fund managers can buy illiquid assets like private equity and private credit. The structure also blunts the risk that investor redemptions might trigger forced sales.

But interval fund structural norms allow for a fair amount of variation in practice.

Morningstar covers data on 100 interval funds with $80.7 billion in AUM, as of May 31, 2024. With Morningstar data, portfolio managers can compare performance and expenses against benchmarks or evaluate repurchase offers.

Our research team dug into the data behind this investment universe to see how managers apply the interval fund structure.

Mutual funds can be sold at the end of every business day at net asset value. ETF shares can be sold during trading hours. With interval funds, investors can only sell shares back to the fund company during specific windows.

These “intervals” must occur at least once per year. While the industry standard is quarterly repurchase offers, some funds offer them monthly or twice a year.

An interval fund board can change that schedule or make repurchase offers at their discretion. One example is Bow River Capital Evergreen. The company pairs twice-a-year formal repurchase offers with two discretionary offers that aren’t guaranteed.

A fund company opens the repurchase window with a written notice sent to each shareholder. This “notice date” typically happens 21 days before the repurchase request deadline, but it can be up to 42 days beforehand. Find the notice date by looking up an interval fund’s name or ticker on the SEC’s EDGAR search under form N-23C3A.

Subject to SEC guidelines, each written notice contains four important dates.

• The effective date, announcing the start of the periodic repurchase offer.
• The repurchase request deadline.
• The NAV date, or when managers determine the fund’s net asset value for repurchases. Per the SEC, the NAV date can be up to 14 days after the repurchase deadline, although the two dates are usually the same. In a all but seven used a pricing date the same as the repurchase deadline.
• The payment date, or the deadline for funds to pay investors the proceeds from their repurchased shares.

Because shareholders must submit a repurchase request before the NAV date, they don’t know the exact share price they’ll receive.

If the interval fund holds sizable illiquid assets, then its NAV is unlikely to change much between the request and NAV dates. Investors could face gains or losses during that period, especially if the full 14 days pass between the deadline and NAV dates.

Interval fund payments can occur up to seven days after the NAV date, according to the SEC. Shareholders can modify or withdraw their repurchase requests any time before the deadline.

In contrast, it takes open-end fund investors two business days to receive their money.

The SEC says that investors must be able to sell 5-25% of outstanding shares back to the fund company in one redemption window.

The fund’s board consults with its managers to set the exact percentage, which can, though often doesn’t, vary with each redemption window. The industry standard is 5% per quarter, which means most interval fund managers should prepare for outflows of up to 20% each year.

Interval funds do have flexibility in setting redemption amounts. Fund managers can redeem another 2% in one window without board approval, even after the notice date. That means most funds can flex up to 7%, often in response to high demand during periods of market stress.

A fund board may also choose to change the repurchase percentage in response to investor demand, year-end tax considerations, or a one-time event such as a change in investment objective.

A higher percentage could signal that the manager believes the strategy is more liquid than the average interval fund. Investors worried about getting their money out may want to prioritize funds with higher redemption percentages.

However, higher percentages undermine the main appeal of interval funds—their ability to buy and hold less-liquid assets. This could potentially reduce total returns and harm shareholders who stay invested during heavy outflows.

Funds manage withdrawals on a pro rata basis. Investors receive money proportionally based on how many shares they own.

The one exception is shareholders who own less than 100 shares and wish to sell all of them. In that case, the fund will meet their redemption, even if total repurchase demand exceeds what the fund offers.

Depending on prospectus guidelines, interval funds can generate financial leverage by borrowing money from an institution like a bank or by issuing preferred shares.

For every three dollars of assets, one can be borrowed. That means up to 33% of fund total assets can come from leverage, or a leverage ratio of 150%.

Limited redemptions can make it easier to maintain financial leverage and access a larger stake in less-liquid assets. But that inherently adds risk to a portfolio.

Remember that leverage is a tool. It can boost returns when applied thoughtfully or lead to devastating outcomes when applied carelessly.

Interval funds appeal to investors who don’t need access to their capital for a long time and who'd benefit from exposure to illiquid asset classes. They seem to work best with assets that generate regular income or can be sold in weeks or months, such as loans and structured credit.

Still, investors should carefully consider the illiquid nature of interval funds themselves—it can take years to fully withdraw your money from one.

Most investors can achieve their financial goals without recourse to this investment vehicle, its attractive features aside.