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Nuances that trip up investment managers forming tender-offer and interval funds

Because of my work with managers on fund formation, I often get early insight into new-product trends. At present, one of the big focus areas is the closed-end space—and, specifically, unlisted funds seeking to offer uncorrelated returns through commercial credit, direct lending and other non-traditional investments. In many cases, the managers forming these funds are adapting an existing strategy from a partnership to a fund structure. In this article, I discuss a few key considerations for investment managers exploring fund formation. 

Interval funds versus tender-offer funds

Structurally, interval funds and tender-offer funds work the same way. Here are highlights on what sets them apart—and can make them similarly challenging for managers—adapted from a conversation I had with Chuck Jaffe on The NAVigator podcast‡.

Purchase and repurchase timing

  • An interval fund typically offers purchases daily, while tender offer funds offer purchases on a monthly or quarterly basis.
  • Both offer repurchases, but interval funds are defined in their offering documents with specific timing and the amount that they will take, while tender offers have more flexibility in the amount tendered and the timing of those tenders.

Investor appropriateness

  • Either could be offered to retail or accredited investors, but what really drives the decision between the two is the type of investments being offered inside of the vehicle and whether there’s going to be a performance fee.
  • Basically, if the underlying investment itself would only be available to accredited investors, then the fund itself would only be available to accredited investors.
  • Also, only accredited investors can invest in a fund that has a performance fee. Retail funds can only have what’s called a fulcrum fee, which is a fee that goes up and down depending on the performance of the fund.

Other considerations

Practically speaking, managers sometimes hope to offer an interval fund structure but run into a roadblock because the industry still primarily requires interval funds to be valued on a daily basis. Some investments, such as a registered private equity fund, simply can’t be valued daily.

Tax considerations: 1099s versus K-1s

Like valuation timing, tax considerations can also throw a monkey wrench into managers’ structural plans. Many investors far prefer receiving a 1099 to a K-1; that’s a definite part of the appeal of this product category. But to issue 1099s, a fund must qualify under the regulated Investment Company requirements of the IRS Code.

Many managers come to us wanting to issue 1099s but then need to go the K-1 route because of their underlying investment strategy, which may not qualify under rules for tax diversification and “good income” tests. (For more details on each of these, as well as other regulatory requirements, I invite you to listen to The NAVigator podcast‡.)

Interval and tender-offer funds versus mutual funds versus private funds

Some readers may be most familiar with registered mutual funds and some with private funds. To help position both interval and tender-offer funds, the following table describes them alongside information about both better-known categories.

This table isn’t comprehensive but points toward many of the key factors that can trip managers up in their fund-formation plans. For a deeper dive into formation topics, see also our white papers on Unlisted Closed End Funds and product conversions.

 

Key Factors for Fund Formation

Mutual Fund

 

Interval Fund

 

Tender Offer Fund Hedge Funds/Private Equity Fund/Qualified Opportunity Zone Fund
Advisor Considerations: Investment adviser must be registered with SEC and comply with requirements of Investment Advisers Act of 1940 Investment adviser must be registered with SEC and comply with requirements of Investment Advisers Act of 1940 Investment adviser must be registered with SEC and comply with requirements of Investment Advisers Act of 1940 Investment Adviser may need to register depending on assets under management
Key Attributes: Investors –    Designed for retail Investors

–    No limits on number of investors

–    Investors can purchase and redeem daily

–    Investors receive 1099s

–    Designed for retail Investors

–    No limits on number of investors

–    Typically, investors can purchase daily and redeem quarterly

–        Investors receive 1099s

–    Designed for high net worth investors

–    No limits on number of investors

–    Typically, monthly subscriptions and quarterly tender offers

–    Investors receive 1099s or K-1s

–    Designed for high net worth investors

–    Number of investors limited by 1933 Act exemption being relied on

–    Typically, monthly subscriptions and periodic redemptions

–    Investors receive K-1s

Key Attributes: Fund –    Limited to investing a maximum of 15% in illiquid assets

General solicitation of potential investors permitted

–    Funds must file reports regarding holdings and audited financial statements in a timely manner

–    No restrictions on illiquid investments

–    General solicitation of potential investors may be permitted.  This will depend on how fund is registered.

–    Funds must file reports regarding holdings and audited financial statements in a timely manner

–    No restrictions on illiquid investments

–    General solicitation of potential investors may be permitted. This will depend on how fund is registered.

–    Funds must file reports regarding holdings and audited financial statements in a timely manner

–    No restrictions on illiquid investments

–    Solicitation limited to qualified investors

–    Funds generally do not have to report holdings or file financial statements (note other adviser disclosure requirements may apply however)

Key Audit Issues –        Valuation for all securities independently verified.

Verifies RIC tax qualifications for diversification and income

–        Valuation for all securities independently verified.

Verifies RIC tax qualifications for diversification and income

–        Valuation for all securities independently verified.

Verifies RIC tax qualifications for diversification and income

–        Conducted in accordance with Generally Accepted Auditing
Standards (GAAS)

UMB Fund Services is a national leader with decades of experience in registered and alternative investment fund servicing. Visit our website to learn how UMB Fund Services can support your firm, or contact us to be connected with a fund services team member.


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