The problem with interval funds
Interval funds are a capital inefficient way to deliver limited liquidity to LPs.
One of the lessons from the Global Financial Crisis is surely that the world doesn’t really need more structural innovation in finance.
Yet structural innovation is back in vogue in the private markets.
In recent weeks, there has been a flurry of new semi-liquid fund structures for VC / growth equity, announced by Hamilton Lane, Stepstone & Coatue. They follow Ark Ventures which launched in 2022.
Interval funds, a niche structure invented in the 1990s to allow for capped redemptions at set intervals, are now above $360bn in total NAV across real estate, credit & private markets.
Goldman Sachs estimates that these semi-liquid structures grew at a staggering ~60% CAGR between 2021 and 2025. Private credit has been the principal growth driver, with private equity (including VC & growth equity) as the newest entrant in the retail alternatives product suite.
Figure 1. Semi-Liquid Market NAV
Each of these new funds have broadly similar goals which is to democratize access to alternatives (including venture capital) by lowering minimums and providing greater liquidity than in a traditional GP/LP fund. Each has selected an interval fund structure whereby investors are provided capped liquidity over a fixed period of time.
The problem: asset liability management
The problem with this model (specifically for illiquid PE/VC) is that the managers need to allocate a significant proportion of the fund to non-core strategies in order to make liquidity available. This is asset liability management.
For example, Coatue is allegedly only investing 20-50% (ie a minority) of the fund in private assets, with the remainder in public stocks and cash. Presumably investors buy this fund for access to hitherto inaccessible private assets. But this is hugely diluted by the public stocks / cash component.
The second related problem is that the mooted liquidity is limited. Both for the private allocation and for the proportion of public stocks / cash. So an allocator is really making three bets in one: 1) the manager is a high quality private market investor, 2) the manager is a high quality public market investor, and 3) the manager can master the right asset mix across the cycle.
This is not investing on the efficient frontier.
Not to talk our own book… but a better model would be to enable an investor to control their public stocks & cash management (with full liquidity), while enabling a 100% allocation to private stocks through a listed-vehicle where an investor can effect liquidity by simply selling (up to 100% of ) their shares (without requiring the manager to liquidate assets in the underlying illiquid private stocks). This structure is an exchange-traded closed end fund (no innovation required). We talked about it here. It also happens to be SignalRank’s structure.
Why now?
You might well ask why there is so much interest in interval funds today (including from The Man In The Arena). Cui bono?
The optimists would argue that democratization of alternatives reduces the power of gatekeepers, should bring additional transparency and will increase capital allocations to the private markets.
The cynics are seeing the emergence of semi-liquid funds as a way for institutional investors to dump the excess of 2020/21 onto retail investors via secondaries. It ends with the proverbial “Belgian dentist” holding the bag. Or in Bloomberg’s Matt Levine’s words: “sophisticated institutions will pay 50 cents on the dollar for this stuff so let’s sell it to retail at 100.” Not good.
What are the implications?
Whatever the question, interval funds are probably not the answer for VC allocators.
Anything that sells itself as a “hybrid structure” (public + private) is unlikely to meet all, or indeed any, of its stated goals. Think hybrid cars. Or hybrid work (remote + in-person). Or hybrid animals (the liger, anyone?). More thought is needed on how to deliver liquidity properly to retail investors.
A more positive framing would be that we expect that the private markets will start to increasingly mimic the public markets. We anticipate the introduction of low-cost passive index funds with full liquidity to absorb an ever greater percentage of assets. The ultimate performance of indices should trump humans’ irrational predisposition to believing in stockpickers. If most public managers cannot beat the public index, shouldn’t the same logic apply to the private markets?
Retail & sovereign funds are powering the growth of alternatives in the next decade. See our prior post on this topic here. Some managers will benefit from this trend in an outsized way (with Blackstone & KKR having a particularly strong start out of the blocks). The trend towards retail PE/VC is not going away. Managers need to adapt accordingly.