There are two types of unlisted closed end funds: interval and tender offer. Both types can work for a wide variety of asset classes and strategies, serving as available tools in investor portfolios. In this article we compare and contrast, outlining the most important similarities and differences between interval and tender offer funds.
Both interval and tender offer funds are regulated under the Investment Company Act of 1940. As a result there are many structural similarities.
Exposure to alternative asset classes
A key advantage of both interval and tender offer funds is the ability for an alternative asset manager to provide access to a wide variety of investors. Alternative investments play an important role in portfolio construction, but have traditionally only been available to accredited investors and institutions. However, many fund sponsors have successfully raised capital in interval and tender offer funds from multiple distribution channels, including both retail and institutional.
Both interval and tender offer funds provide simple 1099 tax statements. These are a lot easier for most investors to deal with than K-1s provided by private placements. Simpler tax reporting leads to broader investor acceptance.
All unlisted closed end funds are registered under the 1940 act, and consequently must provide regular updates in SEC filings. On a semi annual basis, unlisted closed end funds file detailed financial statements on form N-CSR. These semi annual reports must be accompanied by certification by key executives. In their first and third fiscal quarters, both interval and tender offer funds must file form N-Port, which contains monthly portfolio holdings. As a result, investors have a transparent view of how the fund manager is implementing their strategy.
An asset manager launching an interval or tender offer fund must be prepared to keep up with ongoing reporting requirements.
All unlisted closed end funds are subject to leverage limits. In particular, they must maintain 300% asset coverage at all times. This feature is unique to closed end funds. In contrast, BDCS must maintain a 200% asset coverage, and hedge funds don’t have any regulatory leverage limit.
There are several important differences between the two subtypes of unlisted closed end funds. These differences have important implications for investors and fund sponsors.
Repurchase Plans and Asset Liquidity
The most important difference between interval and tender offer funds pertains to share repurchase plans. With an interval fund, the amount and frequency of share repurchase offers are a fundamental policy that can only be changed with shareholder approval. In contrast, with tender offer funds, the board decides whether or not to implement a share repurchase plan. A tender offer fund might make regular repurchases and function just like an interval fund for much of its life, but the key difference is that the board of a tender offer fund can decide to suspend repurchases without shareholder approval.
Interval funds conduct their tender offers under Rule 23c-3 under the 1940 Act (the “Interval Fund Rule”), so they file Form N-23c-3 when conducting tender offers. In contrast, tender offer funds use Rule 13e-4 under the Securities Exchange Act of 1934, so they file form SC TO-I when conducting tender offers. One law firm put out a presentation with a a table showing the difference between these fund types, and another gave a more detailed explanation in an article.
The differences in repurchase plans directly impacts investment strategy. Interval funds generally need to keep part of their portfolio in liquid assets, in order to meet demands for repurchases. In contrast, tender offer funds could theoretically be 100% in illiquid assets, since they don’t don’t always need to provide investors with liquidity. Interval funds can’t gate redemptions. Tender offer funds can.
The liquidity differences are critical issues that concern advisers and end investors. Other differences between interval and tender offer funds involve more subtle regulatory issues that fund sponsors need to deal with.
The launch timelines for interval and tender offer funds are similar- both take about 180 days. Public offerings of both types require SEC review at their initial launch. However, there are subtle differences in the filing process that fund sponsors need to be aware of. Tender offer registration statements must go through the SEC review/comment process annually. On the other hand, once an interval fund is declared effective by the SEC, subsequent registration statements and post-effective amendments get automatic effectiveness. This reduces the legal burden of an interval fund that raises capital over several years.
Also note that unlisted closed end funds can be private or public offerings. However, the 1940 act requires ongoing disclosure, even for funds that are only privately offered. In practice, most interval funds are publicly offered, while tender offers are a mix of public and private offerings.
Pursuant to Rule 5110, Tender offer funds needed to file offering documents and other information to FINRA wivia the Public offering system. In contrast, these FINRA filings are not required for interval funds.
Underwriting Compensation Limits
Fund sponsors also need to consider the different underwriting compensation limits for interval and tender offer funds. Interval funds are subject to FINRA Rule 2341, which prohibits excessive sales charges. The definition of “excessive” varies between service fees and asset based sales charges. According to Sutherland:
Rule 2341 limits the aggregate sales charge to no more than 8.5% of the offering price. This 8.5% aggregate limit
is reduced to 7.25% if the fund pays a “service fee.” If the fund imposes an “asset‐based sales charge” in addition to a “service fee,” then the 7.25% cap is lowered to 6.25% of the total gross sales. If the fund only has an “asset‐based sales charge” and no “service fee,” the aggregate limit is also 7.25%. The asset‐based sales charge is also subject to an annual cap of 0.75% of the average annual net assets of the fund.
Underwriting compensation for tender offer funds is subject to a different rule: FINRA Rule 5110. This rule states that underwriting compensation must be limited under a “fair and reasonable” standard. In practice, FINRA interprets this as 8%.
Of course, actual market demands often restrict underwriting compensation beyond regulatory requirements. Due diligence officers at broker dealers and RIAs might view higher than market average sales compensation as a negative.
Organization and Offering Expense Limit
There are no strict limits on organization and offering expenses for interval funds. In contrast, tender offer funds are subject to FINRA Rule 5110, which applies the “fair and reasonable” standard. Fund disclosures must include all items of value received as compensation for organization and offering expenses. As with other fund expenses, market forces often force asset managers to charge well below regulatory limits.
Other Useful Resources
Interval and Tender Offer Closed End Funds: Investment Company Alternatives to Traditional Funds –Chapman and Cutler LLP
Interval and Tender Offer Funds – Ultimus Fund Solutions
Non‐Traded Structures: Raising Capital in an Unlisted Environment -Eversheds Sutherland