Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
BTW, the earliest reference to interval-funds at MFO that I could find was in 2013 by @David_Snowball who was reporting on M* Investment Conference about this new thing called IFs.
In looking over some old MFO posts, I also saw some mixed-up usage of terminology related to NT-REITs, NT-BDCs and IFs. Well, luckily, they are all very similar but still distinct.
As I've said before, I like the idea of interval and non-traded funds/investments. It's the execution so far I have a problem with. I challenge anyone to find a truly low-cost interval fund that is unlevered and currently open to investment by retail investors. They all so far seem significantly overpriced, the rational being they are investing in unusual assets. The truth is the assets some of them invest in like private debt are not that unusual. The funds are overpriced because of the limited supply of them, and managers charge more for that reason. Meanwhile, they are leveraged to gather more assets and collect more fees on those assets, significantly increasing their risk profiles unecessarily. To use a grammar and English faux pas, the structure needs to be "Vanguard-ized." A low-cost unlevered interval fund could be very attractive.
The other problem is a lack of transparency regarding their pricing on illiqid assets. But that is the nature of the beast, and I can accept that to a degree in a fund that benefits from investing in illiquid assets, so long as it's from a reputable issuer with truly independent valuation analysis of its portfolio. I think stale pricing almost certainly exists in many funds, but it is better for such funds to invest in illquid assets than regular mutual funds or ETFs. We've seen what happens when daily-redemption mutual funds invest in illiquid securities they have no business investing in.
I'm personally invested in interval funds NICHX and CELFX for what I believe are good risk adjusted returns. Currently evaluating CEDIX.
** Not investment advice by any means, buyer beware **
Fwiw, I was fixated on ER's for more than 20 years and hewed to strict limits of 1.25% with very few exceptions over those years. However I'm now more focussed on strategy, pedigree and what's going to end up in my pocket compared to the alternatives. Not stating that cost controls aren't important and also not stating that my current view is right for everybody but in general while I believe cost should be a factor it should not be a means to automatically eliminate. The cost should be viewed along with other factors -- strategy, risk, etc.. I love Vanguard products and focus on cost but Vanguard funds don't always result in the highest(or safest) net returns
Niche investment strategies and steady returns will command a fee premium, it is what it is.
PIMCO recently launched a new interval fund, the PIMCO Flexible Real Estate Income Fund (REFLX).
Q: Why is PIMCO launching REFLX now?
Donner: Private real estate markets are repricing and yields have risen, amplifying opportunities for both income and total return. Asset repricing has not been uniform across the real estate asset landscape: Valuations in public real estate markets have tumbled, while private market assets are in earlier stages of repricing. Flexible real estate funds like REFLX can capitalize on this dislocation, focusing on segments of the market that offer the most attractive return profile. As a new portfolio, REFLX does not have the burden of legacy holdings weighing on its earnings and return potential, providing the managers even more investment flexibility.
@Observant1, interesting info about REFLX REIT under the newer interval-fund structure, not the older, opaque Nontraded-REIT structure.
So, DAILY valuations, DAILY purchases at NAV at market close (may include applicable sales load), minimum 5% REDEMPTION per quarter. Purchase MINIMUM of $1 million mentioned in the prospectus but not in other web or PR documents (brokers and financial advisors may have other minimums); institutional class only for now.
@StayCalm The smoothness of the returns of NICHX and CELFX during periods of distress makes me less comfortable, not more, about investing in them. Here is how various publicly traded debt markets traded in March of 2020 during the worst of the pandemic decline: https://wstam.com/news/market-updates/march-2020-fixed-income-market-review/ Yet CELFX, which invests in junk rated credits only fell 2%. The public floating rate market fell 8% and the high yield market 11%. They invest in comparable credits from a risk of default perspective. That indicates to me stale pricing in illiquid assets in CELFX. It is arguable that public markets oversold, yet by how much? In a period of true long-term distress instead of a flash followed by a government bailout like March of 2020, defaults rise, liquidity dries up and even private debt as interval fund shareholders gradually redeem will need to reflect market pricing as opposed to some stale assessment of valuation by a fund board or pricing service hired by the board. All of which is to say I do not think those March 2020 numbers reflected reality as to what those assets were worth at that moment.
Meanwhile, CELFX is charging a 2.5% total expense ratio including acquired fund fees and administrative costs while currently yielding 8.9%. With Treasuries yielding 4% without fees subtracted, a fund cannot yield 8.9% today without taking on significant credit and/or leverage risk. Pricing of its assets should reflect those risks when public debt markets slide.
- NICHX and CELFX invest in a wide variety of debt instruments, not just corporate debt. For example litigation financing, structured capital, royalties, etc.. - Both are debt specialists with pedigree and a track record. This is their bread and butter, they're not generalist debt analysts within a 60/40 fund and unlike many debt funds both spread the net quite broad when it comes to portfolio assets.
That's not to say that a Madoff like event cannot happen to either one of above. The main advantage of interval funds is that one is less affected by the daily gyrations of the market and through gating policies managers can prevent a stampede to the exits which open ended mutual funds do not have the capability to do so. At inflection points, herd behavior rules and is what causes perm losses.
Regards your comments on stale pricing, interval funds allow for quarterly redemptions so the NAV needs to be at least close to reality for the fund managers to allow redemptions else if there is a large disconnect, the managers are effectively handing out dollar bills for 80c.
Not following your comparison to Treasuries because that is kinda table stakes for any debt or equity fund that performs above benchmarks, nothing unique in CELFX or NICHX about that. Giroux at PRWCX or BRUFX managers did not build their long term track records and beat their benchmarks by buying plain vanilla Treauries or being closet indexers on equity side.
It’s not what CELFX is investing in that is the problem I am identifying but how much it’s yielding above Treasuries, i.e., the yield spread, after deducting significant fees without showing any apparent volatility while public markets invested in similar low credit quality debt show significant volatility. Its NAV is behaving as though it invests in high quality low risk credit while it is actually investing in the opposite. You can’t earn 11% today before fees when Treasuries are yielding 4% without taking significant default risk. I don’t think the pricing of the fund reflects that risk. And I am fairly certain it didn’t reflect that risk in March of 2020.
I believe you are implying that there is funny business going on based on the return profile and that managers cannot generate strong alpha within the debt or alternative space.
Out of sheer curiosity what are the top 2-3 positions in your portfolio?
The stale pricing issue I am describing is not necessarily particular to this fund but a universal one that is particularly relevant though with private funds that don’t price every day. Most corporate debt funds don’t have pricing that reflects market reality.
I don’t care how skilled of a bank loan manager or high yield bond fund manager one is, in March of 2020 when the whole world was falling apart, there was no way a high risk credit manager could liquidate their portfolios with only a 2% haircut in that environment. To say the portfolio’s liquidation value only fell 2% then is unrealistic.
DAILY PRICING of illiquid securities may not be reliable. The 3rd party pricing services may use matrix pricing or guesswork for things that haven’t traded recently. This would affect interval-funds as well as normal OEFs/ETFs/CEFs. The difference may be that when there are concerns like this, those may be reflected in OEF and ETF outflows and CEF discounts, but those mechanisms are limited or not available for interval-funds.
Pricing of illiquid assets is part science and part art but to connect that reality to a blanket statement along the lines of "ergo all these returns are bogus" is quite a leap.
The issue of the "correct" price for thinly traded or illiquid assets isn't just restricted to debt, it applies to equity mutual funds and ETF's too. It's a different thing to express disagreement on established norms for valuing thinly traded assets (L2, L3 quotes, private valuations, comparable securities, etc..) vs. saying the managers are committing fraud.
The two stats that caught my eye from the links posted by @Lewis were -- $1.2B aggregate loss to buy and holders due to traders gaming the illiquidity -- 4 bips of return loss
Admittedly these numbers are above zero but in the context of the bond market $1.2B is less than a rounding error and I personally would not let "theft" of 0.04% deter me from investing in an asset class plus interval funds have lower exposure to the theft.
But that's just me and my 2c on the topic. Over and out.
I never said in any of my posts the managers were committing fraud. The appropriate term, "returns smoothing," would be as described in the Advisor Perspectives article:
Stale pricing can create problems for investors. For example, funds are incented to engage in “return smoothing” by selective use of valuations
There can be disagreement as to what the "fair value" of a private security is precisely because it does not trade and in many cases could be one of a kind. That's not fraud, but let's just say the pricing can tend to favor the managers of the funds when there is a debate between what they see as the intrinsic value of a private security is versus what the market says publicly traded securities with very similar credit qualities, businesses and risks are worth.
It reminds me almost of how General Electric used to smooth earnings out so they hit their targets every quarter for many years. I don't think it was ever labeled fraud, but it was disingenuous as to what the company was actually producing earnings wise each quarter. I would trust an interval fund more that marked its portfolio down more during March of 2020 and simply issued a letter to shareholders stating: "We don't think any of our portfolio companies are impaired at this point but the market thinks there is a risk that there could be impairment in the future and so the market is marking down all high risk securities and we are marking ours down accordingly. The good news is because we are an interval fund we are not facing a run on the bank situation like an open-end fund would and if we're right and there is no impairment we should recover all of those losses."
CELFX did not exist in March 2020. Just saying. Inception date is July 1, 2021
Swedroe is certainly a known name but the conclusion of his linked AP article is as per below.
"Bond investors can avoid the risks and costs created by stale pricing in mutual funds by either building their own individual portfolios or engaging a separate account manager."
First suggestion isn't actionable by the vast majority of individual investors due to the size of the individual bond portfolio needed for adequate diversification and the second suggestion is Swedroe and Advisor Perspectives hawking their wares (nothing wrong with that, just pointing it out). There are no free lunches.
So would one rather avoid bond funds altogether due to losing 0.04% or invest through RIA who will cost a lot more than 0.04%?
@StayCalm You are right. I was referring to another interval fund— CCFLX—run by the same manager Cliffwater. But the issue regarding pricing for private securities for both funds is the same. The question comes down to whether securities are mark-to-market or does the manager use some “fair value” estimation: https://investopedia.com/terms/m/marktomarket.asp I can say the disparity in valuation between what the market thinks the value of illiquid low credit quality securities is versus the managers’ private assessment of that value has been far greater than 0.04% during periods of stress. I’ve witnessed this phenomenon firsthand with the disparity between the public market value of BDCs that invest in illiquid private floating rate loans and the BDCs estimate of that valuation. I’ve seen discounts as high as 50% in bad periods.
The distinction matters because if a loan has a face value of $100 million and the manager has a 2% management fee, they collect $2 million in fees on that loan. But if they marked it down to $50 million during a period of public market distress, they only collect a $1 million fee. So, there is an inherent conflict of interest favoring a more optimistic outlook than the market regarding portfolio value to collect more fees.
What I’ve seen happen in cases where the market is proven right— that the underlying portfolio of credits is impaired and should be marked down—is the manager does this very slowly. Each quarter there is a gradual reduction in NAV that is sadly predictable. This way the manager can keep collecting fees on an inflated portfolio value. This is the “auto correlation” the Advisor Perspectives article was talking about. Because of the “returns smoothing” the first mover who gets out as soon as there is a markdown gets a better return than they deserve as the portfolio should have been marked down earlier. Meanwhile, the person who holds on gets a worse return than they deserve.
In the open end mutual fund space some of these overly optimistic pricings of illiquid securities have proven disastrous where the manager doesn’t mark down the portfolio but suddenly when facing redemptions has to sell those illiquid securities and accept what the market really thinks the portfolio is worth. Then you see these huge markdowns in one or two days. Interval funds don’t have that forced selling issue nearly as much. Yet I still think they should mark their portfolios appropriately during volatile periods. That completely smooth upward sloping line for returns no matter what public market conditions are does not reflect reality.
Forecasting, having and using cash reserves + line of credit to prevent a run on the bank is a common practice amongst seasoned managers.
Managers who have spent a decade or more to build a reputation will "generally" not resort to ethically questionable practices at the risk of the fund blowing up. You've described a few BDC's taking a 50% haircut but this is anecdotal stuff as opposed to the hard 4 bips and $1.2B loss numbers estimated (as an overall market aggregate) in the article link you provided.
Any financial investment outside of FDIC guaranteed CD's and US Govt guaranteed bonds can blow up. During the last crisis some MM funds broke the buck which was deemed unthinkable.
The ghost of Bernie can emerge anytime and anywhere and a dozen or more things can go wrong outside of CD/USG bonds.
Should all of that result in one investing only in the guaranteed stuff? Personal to everyone of course and clearly you and I have different views on this.
Investing beyond the guaranteed stuff entails risk of partial or full loss even if the auditors are one of the Big 4. It comes down to investing based on an individual assessment of the risk/return tradeoffs.
Comments
In looking over some old MFO posts, I also saw some mixed-up usage of terminology related to NT-REITs, NT-BDCs and IFs. Well, luckily, they are all very similar but still distinct.
The other problem is a lack of transparency regarding their pricing on illiqid assets. But that is the nature of the beast, and I can accept that to a degree in a fund that benefits from investing in illiquid assets, so long as it's from a reputable issuer with truly independent valuation analysis of its portfolio. I think stale pricing almost certainly exists in many funds, but it is better for such funds to invest in illquid assets than regular mutual funds or ETFs. We've seen what happens when daily-redemption mutual funds invest in illiquid securities they have no business investing in.
** Not investment advice by any means, buyer beware **
Fwiw, I was fixated on ER's for more than 20 years and hewed to strict limits of 1.25% with very few exceptions over those years. However I'm now more focussed on strategy, pedigree and what's going to end up in my pocket compared to the alternatives. Not stating that cost controls aren't important and also not stating that my current view is right for everybody but in general while I believe cost should be a factor it should not be a means to automatically eliminate. The cost should be viewed along with other factors -- strategy, risk, etc.. I love Vanguard products and focus on cost but Vanguard funds don't always result in the highest(or safest) net returns
Niche investment strategies and steady returns will command a fee premium, it is what it is.
Q: Why is PIMCO launching REFLX now?
Donner: Private real estate markets are repricing and yields have risen, amplifying opportunities for both income and total return. Asset repricing has not been uniform across the real estate asset landscape: Valuations in public real estate markets have tumbled, while private market assets are in earlier stages of repricing. Flexible real estate funds like REFLX can capitalize on this dislocation, focusing on segments of the market that offer the most attractive return profile. As a new portfolio, REFLX does not have the burden of legacy holdings weighing on its earnings and return potential, providing the managers even more investment flexibility.
Link
Note: This should not be construed as a recommendation.
So, DAILY valuations, DAILY purchases at NAV at market close (may include applicable sales load), minimum 5% REDEMPTION per quarter. Purchase MINIMUM of $1 million mentioned in the prospectus but not in other web or PR documents (brokers and financial advisors may have other minimums); institutional class only for now.
Prospectus
Yet CELFX, which invests in junk rated credits only fell 2%. The public floating rate market fell 8% and the high yield market 11%. They invest in comparable credits from a risk of default perspective. That indicates to me stale pricing in illiquid assets in CELFX. It is arguable that public markets oversold, yet by how much? In a period of true long-term distress instead of a flash followed by a government bailout like March of 2020, defaults rise, liquidity dries up and even private debt as interval fund shareholders gradually redeem will need to reflect market pricing as opposed to some stale assessment of valuation by a fund board or pricing service hired by the board. All of which is to say I do not think those March 2020 numbers reflected reality as to what those assets were worth at that moment.
Meanwhile, CELFX is charging a 2.5% total expense ratio including acquired fund fees and administrative costs while currently yielding 8.9%. With Treasuries yielding 4% without fees subtracted, a fund cannot yield 8.9% today without taking on significant credit and/or leverage risk. Pricing of its assets should reflect those risks when public debt markets slide.
- NICHX and CELFX invest in a wide variety of debt instruments, not just corporate debt. For example litigation financing, structured capital, royalties, etc..
- Both are debt specialists with pedigree and a track record. This is their bread and butter, they're not generalist debt analysts within a 60/40 fund and unlike many debt funds both spread the net quite broad when it comes to portfolio assets.
That's not to say that a Madoff like event cannot happen to either one of above. The main advantage of interval funds is that one is less affected by the daily gyrations of the market and through gating policies managers can prevent a stampede to the exits which open ended mutual funds do not have the capability to do so. At inflection points, herd behavior rules and is what causes perm losses.
Regards your comments on stale pricing, interval funds allow for quarterly redemptions so the NAV needs to be at least close to reality for the fund managers to allow redemptions else if there is a large disconnect, the managers are effectively handing out dollar bills for 80c.
Not following your comparison to Treasuries because that is kinda table stakes for any debt or equity fund that performs above benchmarks, nothing unique in CELFX or NICHX about that. Giroux at PRWCX or BRUFX managers did not build their long term track records and beat their benchmarks by buying plain vanilla Treauries or being closet indexers on equity side.
I believe you are implying that there is funny business going on based on the return profile and that managers cannot generate strong alpha within the debt or alternative space.
Out of sheer curiosity what are the top 2-3 positions in your portfolio?
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3244862
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2978284
https://advisorperspectives.com/articles/2022/09/25/stale-pricing-and-the-risk-to-bond-fund-investors
I don’t care how skilled of a bank loan manager or high yield bond fund manager one is, in March of 2020 when the whole world was falling apart, there was no way a high risk credit manager could liquidate their portfolios with only a 2% haircut in that environment. To say the portfolio’s liquidation value only fell 2% then is unrealistic.
As for my largest position, cash remains it.
The issue of the "correct" price for thinly traded or illiquid assets isn't just restricted to debt, it applies to equity mutual funds and ETF's too. It's a different thing to express disagreement on established norms for valuing thinly traded assets (L2, L3 quotes, private valuations, comparable securities, etc..) vs. saying the managers are committing fraud.
To each their own.
-- $1.2B aggregate loss to buy and holders due to traders gaming the illiquidity
-- 4 bips of return loss
Admittedly these numbers are above zero but in the context of the bond market $1.2B is less than a rounding error and I personally would not let "theft" of 0.04% deter me from investing in an asset class plus interval funds have lower exposure to the theft.
But that's just me and my 2c on the topic. Over and out.
It reminds me almost of how General Electric used to smooth earnings out so they hit their targets every quarter for many years. I don't think it was ever labeled fraud, but it was disingenuous as to what the company was actually producing earnings wise each quarter. I would trust an interval fund more that marked its portfolio down more during March of 2020 and simply issued a letter to shareholders stating: "We don't think any of our portfolio companies are impaired at this point but the market thinks there is a risk that there could be impairment in the future and so the market is marking down all high risk securities and we are marking ours down accordingly. The good news is because we are an interval fund we are not facing a run on the bank situation like an open-end fund would and if we're right and there is no impairment we should recover all of those losses."
Swedroe is certainly a known name but the conclusion of his linked AP article is as per below.
"Bond investors can avoid the risks and costs created by stale pricing in mutual funds by either building their own individual portfolios or engaging a separate account manager."
First suggestion isn't actionable by the vast majority of individual investors due to the size of the individual bond portfolio needed for adequate diversification and the second suggestion is Swedroe and Advisor Perspectives hawking their wares (nothing wrong with that, just pointing it out). There are no free lunches.
So would one rather avoid bond funds altogether due to losing 0.04% or invest through RIA who will cost a lot more than 0.04%?
To each their own.
I can say the disparity in valuation between what the market thinks the value of illiquid low credit quality securities is versus the managers’ private assessment of that value has been far greater than 0.04% during periods of stress. I’ve witnessed this phenomenon firsthand with the disparity between the public market value of BDCs that invest in illiquid private floating rate loans and the BDCs estimate of that valuation. I’ve seen discounts as high as 50% in bad periods.
The distinction matters because if a loan has a face value of $100 million and the manager has a 2% management fee, they collect $2 million in fees on that loan. But if they marked it down to $50 million during a period of public market distress, they only collect a $1 million fee. So, there is an inherent conflict of interest favoring a more optimistic outlook than the market regarding portfolio value to collect more fees.
What I’ve seen happen in cases where the market is proven right— that the underlying portfolio of credits is impaired and should be marked down—is the manager does this very slowly. Each quarter there is a gradual reduction in NAV that is sadly predictable. This way the manager can keep collecting fees on an inflated portfolio value. This is the “auto correlation” the Advisor Perspectives article was talking about. Because of the “returns smoothing” the first mover who gets out as soon as there is a markdown gets a better return than they deserve as the portfolio should have been marked down earlier. Meanwhile, the person who holds on gets a worse return than they deserve.
In the open end mutual fund space some of these overly optimistic pricings of illiquid securities have proven disastrous where the manager doesn’t mark down the portfolio but suddenly when facing redemptions has to sell those illiquid securities and accept what the market really thinks the portfolio is worth. Then you see these huge markdowns in one or two days. Interval funds don’t have that forced selling issue nearly as much. Yet I still think they should mark their portfolios appropriately during volatile periods. That completely smooth upward sloping line for returns no matter what public market conditions are does not reflect reality.
Forecasting, having and using cash reserves + line of credit to prevent a run on the bank is a common practice amongst seasoned managers.
Managers who have spent a decade or more to build a reputation will "generally" not resort to ethically questionable practices at the risk of the fund blowing up. You've described a few BDC's taking a 50% haircut but this is anecdotal stuff as opposed to the hard 4 bips and $1.2B loss numbers estimated (as an overall market aggregate) in the article link you provided.
Any financial investment outside of FDIC guaranteed CD's and US Govt guaranteed bonds can blow up. During the last crisis some MM funds broke the buck which was deemed unthinkable.
The ghost of Bernie can emerge anytime and anywhere and a dozen or more things can go wrong outside of CD/USG bonds.
Should all of that result in one investing only in the guaranteed stuff? Personal to everyone of course and clearly you and I have different views on this.
Investing beyond the guaranteed stuff entails risk of partial or full loss even if the auditors are one of the Big 4. It comes down to investing based on an individual assessment of the risk/return tradeoffs.