US credit managers are raising new interval funds which give retail investors access to alternative assets that can offer better returns than more traditional mutual fund holdings. Managers including OppenheimerFunds in partnership with Carlyle Group, and Flat Rock Global have registered to raise interval funds in the last year, according to regulatory filings.
"There's a trend towards interval funds as a new solution of bringing retail investors access to alternative strategies," said Dustin Norris, head of distribution and chief product strategist at Highland Capital Management. "The interval fund wrapper allows for a much larger pool of illiquid investments with less concern about daily liquidity."
The funds make a range of investments in Collateralized Loan Obligations (CLOs), Commercial Mortgage-Backed Securities (CMBS) and more traditional credit assets including leveraged loans and high-yield bonds.
Interval funds are having a renaissance as managers try to generate higher returns after years of low interest rates and target retail investors to broaden their buyer base. The funds also sidestep new onerous Securities and Exchange Commission rules aimed at improving the liquidity of mutual funds popular in retirement accounts.
Interval funds make periodic repurchase offers to shareholders, generally every three, six or 12 months and differ from open-end mutual funds as they are less liquid. Open-end mutual funds have daily redemptions and target retail investors that trade with personal accounts and are thus attracted to their daily liquidity.
Firms launching interval funds are betting that retail investors will be interested in products that can generate meatier returns by buying less liquid assets, including leveraged loans and structured credit. The downside is that investors cannot get their money back at short notice, unlike open-end funds.
"Alternative managers are looking to access the growing retail marketplace and firms can put more illiquid assets in an interval fund than a mutual fund because you don't have to meet redemptions each day," according to Kimberly Flynn, a managing director at XA Investments.
Interval funds are becoming more popular. Other asset classes, including commercial real estate, began raising interval funds a few years ago, according to Brian Moriarty, analyst of fixed-income strategies at Morningstar, but loans and structured credit are now having their day.
The new interval funds can give retail investors access to alternative investment products that were previously only available to institutional investors, according to Robert Grunewald, chief executive officer at Flat Rock. The funds are coming to the market just as the underlying investments are surging in issuance. More than US$43bn of US CLOs has been raised this year through May 8, up almost 43% from the same period last year, according to Thomson Reuters LPC Collateral data. US CMBS issuance is up more than 54% this year through May 4 from the same timeframe in 2017, according to Bank of America Merrill Lynch data.
US CLO equity, the most junior part of the funds, returned 16.4% in 2017, compared to 4.1% for US leveraged loans and 6.3% for US high-yield bonds, according to Citigroup data.
Firms "have to solve the puzzle of how you give investors the right amount of liquidity so the investor isn't locked up in a-style 10-year plus investment, while still delivering on the investor promise and thesis of underlying assets that are illiquid," said Nathan Greene, head of law firm Shearman & Sterling's registered funds and investment adviser regulatory group.
OppenheimerFunds and Carlyle partnered for the OFI Carlyle Private Credit Fund, which will invest in direct lending first- and second-lien loans, unitranche loans, mezzanine debt and CLOs, while Flat Rock is seeking to raise the Flat Rock Opportunity Fund to invest in CLO equity and junior debt tranches, according to regulatory filings. Spokespeople for OppenheimerFunds and Carlyle both declined to comment. Late last year Angel Oak Capital launched its Angel Oak Strategic Credit Fund that invests in CLOs, CMBS and residential mortgage-backed securities, according to regulatory filings.
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