From tender offer funds to BDCs: what to look for in registered alternative vehicles

Historically, most private alternative investments, including private real assets, equity, and credit have only been available to qualified purchasers such as endowments, foundations, pension funds, and family offices in the form of limited partnerships. However, greater innovation has led to an evolution in registered alternative vehicles, producing structures that give individual investors access to these private assets. But with a proliferation of vehicles ranging from interval and tender-offer funds to non-traded real estate investment trusts (REITs) and business development companies (BDCs) covering a wide variety of strategies and product features, picking the best fit for any investor can be challenging. Moreover, selecting the right firm to partner with requires caution. Below are four considerations we believe every financial professional should make.

1   Not all providers are created equal: assess expertise carefully

Rising demand for access to private alternative investments has spurred product launches from both traditional and alternative asset managers. However, bridging public and private markets isn’t a simple endeavor. It requires both public market operational infrastructure and private markets investment expertise—a unique combination that not all firms can deliver. Many traditional asset managers offer robust operational infrastructure that include administering liquid, regulated investment vehicles, but they’re often latecomers to alternative strategies and private markets from an investing perspective. This often means a lack of expertise and deep relationship networks that are important aspects of identifying and assessing complex investment opportunities. Meanwhile, alternative asset managers often bring investment expertise and knowledge but may lack the operational infrastructure necessary to manage liquid, registered vehicles, and Investment Company Act of 1940 funds. Not many firms have a proven track record of operating in both public and private markets. Therefore, it’s essential that financial professionals pay attention to not only investment expertise, but also operational capabilities. Failure to comply with regulatory standards can result in a fund losing its registered status. Among other things, this may lead to financial professionals and investors having to untangle a complex web of tax consequences.

2     Understand the liquidity and risk/return profile of underlying assets

Registered alternative vehicles are introducing more liquidity; however, underlying holdings may contain a mix of liquid and illiquid securities. Different registered vehicles cater to different asset liquidity profiles. For example, interval funds are required to offer periodic liquidity to investors so typically tilt toward holding more liquid underlying assets, while tender-offer funds, BDCs, and non-traded REITs tilt toward holding illiquid assets. It’s important to carefully examine underlying holdings to ensure that the liquidity and risk/return profile of underlying assets aligns with an investor’s investment objectives and liquidity expectations. Even with improved liquidity, alternative funds often have redemption limits, which can be found on offering documents and are important for financial professionals to review. From a risk/return perspective, illiquid assets are expected to provide an illiquidity premium and lower correlation and volatility compared with traditional stocks and bonds, which are potential features that draw investors to alternative strategies.

3    Be aware, valuation methods aren’t standardized

Unlike daily liquid mutual funds, registered alternative vehicles don’t follow standardized valuation practices. Each firm implements proprietary policies for valuing private assets. As such, financial professionals should examine the frequency and timeliness of valuation marks to ascertain appropriateness for both the registered vehicle and type of assets held. For instance, some interval funds may indicate daily valuations, whereas the private assets held by some funds are typically valued on a quarterly basis with a two-month lag. Being aware of these potential mismatches can help financial professionals inquire further and achieve clarity before making an investment decision. To gain greater transparency on the valuation of underlying holdings, financial professionals should request information on third-party asset appraisers to examine, among other things, that a reputable, registered external firm has been appointed. Since private assets are typically valued externally on a quarterly basis or internally on a monthly basis, valuation professionals generally consider monthly valuations to be reasonable; however, valuations conducted at a higher frequency than monthly are viewed as less reliable by many experts.

4    Fees and yields are highly nuanced

Fees and yields associated with registered alternative products are more nuanced than mutual funds because of the use of leverage and the inclusion of performance fees. For example, two registered alternative funds can charge the same management fee on managed assets (total assets including leverage) but the fund with higher leverage actually has a higher management fee, which would reflect if comparing management fees on net assets (total assets without leverage) of the two funds. Interest expenses may vary based on a fund's use of leverage, while performance fees vary depending on actual performance and whether the charging basis is on income or capital and the hurdle rate. For vehicles with an income focus, distribution yield is a key measure, but it’s important for investors to review the source of yield to assess its sustainability and associated risks as higher yield may be due to higher leverage, depressed asset values, or riskier underlying assets and, in some cases, even due to the return of capital. Given the complexity associated with fees and yields, total returns may be the best quantitative measure to use when assessing different registered alternative vehicles.

The benefits of partnering with the right investment firm

Registered alternative investment vehicles span the liquidity and regulatory spectrum and can hold a mix of liquid and illiquid assets. Understanding the differences in investment vehicles, assessing underlying assets held, and how managers apply valuations and report performance can be challenging. Partnering with an experienced investment firm with both a heritage of private markets investing and public market operational expertise and experience can be a key differentiator for financial professionals looking to access the benefits that alternative strategies and private markets may offer.