What Are Interval Funds and How Do They Work?

Investors are attracted to many different types of investment funds depending on their goals. There are two broad categories of funds: closed- and open-ended ones. Closed-end funds, such as municipal bond funds and some global investment funds, raise capital via an initial public offering (IPO), invest in stocks, bonds and other securities, and are traded on a stock exchange. Open-end funds, such as most mutual funds, allow regular contributions and withdrawals from investors and are not traded on an exchange. Interval funds straddle these two types of investments, combining some features of both.

What are interval funds?

Interval funds are a type of investment company that buys its own shares back from investors at various predetermined times of the year, or intervals. There is no secondary market for interval funds, so their shares must be purchased directly from the investment company that manages the fund. Interval fund shares are continually sold by the companies themselves, which means that investors don’t have to wait for an IPO to buy.

Investors who buy shares own a portion of the assets that the fund manager purchases with the proceeds of the sales. As the value of the pooled investment grows, the shares increase in value. Investors can then sell the shares for a profit, though there’s a catch: They can only sell them back to the company at fixed and specific periods, typically once per quarter. When funds offer to repurchase shares, they will buy back only a percent of the shares outstanding (between 5% and 25%), which can limit an investor’s ability to liquidate.

Because investors can’t pull money out whenever they want, interval funds are immune to a run,  which can happen when many investors want to pull their money out at the same time. This gives the fund the flexibility to invest in higher-yield, more illiquid assets like residential or commercial real estate, stock in privately held companies, and infrastructure loans. Because interval funds generally hold a larger percentage of illiquid investments, they are less affected by the short-term volatility of  financial markets. 

The price of an interval fund’s shares is determined by its net asset value, or NAV, which is the total value of the fund’s pool of investments minus liabilities. It is typically shown on a per-share basis by dividing NAV by the number of shares issued. NAV is calculated daily and is displayed on the fund’s website, which is also where people buy interval funds.  

An interval fund is categorized by law as a type of closed-end fund, which is a kind of mutual fund that issues a fixed number of shares through a single initial public offering (IPO) to raise capital, then never issues new shares and accepts no new money. But unlike closed-end funds, interval funds are not listed on a secondary exchange.

Interval funds vs. other types of funds

Interval funds have some characteristics of both open-end funds, which sell directly to investors and can issue more and more shares over time, and closed-end funds, which issue a fixed number of shares through a single IPO. Although they are technically classified as closed-end funds, interval funds sell shares continuously and buy them back periodically. They generally don’t raise funds via an IPO or trade on an exchange. Interval funds are differentiated from other types of funds in several important ways:

• Interval funds vs. mutual funds

  . Interval funds contain more long-term, illiquid assets than most mutual funds, which typically hold a mix of stocks and bonds. That means interval funds are also less subject to the volatility of the stock market than are most mutual funds. While mutual fund investors can buy and sell their shares in a mutual fund whenever the markets are open, interval funds allow investors to sell back to the fund only at specific times.

• Interval funds vs. ETFs

  . Exchange-traded funds (ETFs) trade on exchanges the same way a regular stock does and typically track a specific index, sector, or commodity. They can contain all kinds of assets but rarely contain illiquid assets. ETFs are popular because they can be quickly bought and sold, but they are also less stable than interval funds, which are designed to withstand rapid short-term declines in markets.

• Interval funds vs. closed-end funds

  . Interval funds offer shares continuously and don’t typically raise funds through an IPO. Closed-end funds raise their capital all at once via an IPO and don’t offer new shares after that. Closed-end funds can only be bought from other investors on a secondary market, and for this reason, may trade above or below the fund’s NAV. Interval funds are more often traded at the NAV price. 

Potential benefits and risks of investing in interval funds

Interval funds are one way to invest in illiquid assets which may yield more income and potentially be less volatile than other types of funds. Like any investment, interval funds carry their own benefits and risks. 

Potential benefits of investing in interval funds include: 

• High yields

  . Interval fund managers can invest without the pressure of frequent redemption demands from shareholders. Because fund managers can plan for the intervals when they’ll buy back shares, they can invest in less liquid long-term assets such as real estate, consumer loans, infrastructure, and private equity, which may offer higher yields.

• Less volatility

  . Because interval funds are typically invested in less liquid assets that are not easily traded in the markets, they tend to be less volatile than stock or bond markets. Interval funds are also less subject to the emotional buying and selling that happens in the secondary markets. 

On the other hand, the structure of interval funds can be a drawback for investors, for reasons including:

• Illiquidity.

  Investors can only sell their fund shares at certain intervals, and the fund will only buy back between 5% and 25% of its assets during each of those intervals. The length of time an investor may sell shares varies from a few weeks or shorter. And if an investor misses the window, they’ll have to wait until the next interval. This means investors may not be able to sell shares when they want to, or the amount that they would like to.

• Higher costs.

  A minimum investment in an interval fund is often high and can run from $10,000 and $25,000. They can also charge management and operating fees of 3% or even higher on top of sales charges of 5.75%. These costs are typically much higher than those of mutual funds and ETFs, which can be as low as 0.03%. 

• Complicated structure and holdings

  . The structure of an interval fund, which offers shares constantly to investors but only buys them back at intervals and only at certain percentages, is more complex than a mutual fund or an ETF that can be traded with ease. Interval funds also tend to invest in opaque assets like private equity and real estate, which, bundled, may be difficult to understand and are hard to value. This makes it more difficult for average retail investors to understand what it is they’re investing in.

The bottom line

Interval funds are investment companies that combine some characteristics of both open-end and closed-end funds. Investors can buy them at any time, but they can only sell their shares at certain intervals. The shares are not traded on an exchange and do not come onto the market via an IPO. These funds are designed to invest in illiquid assets for the long term. 

Since they can avoid unexpected requests to sell, interval funds are not as affected by the short-term movements of markets because of the kinds of investments they hold. Interval funds can be less volatile than other funds and lead to potentially more gain, but they are also more illiquid and have higher barriers to entry.