Pros and Cons of Investing in Interval Funds

bar graph_quarter
••• iStock Photos

An interval fund is an alternative type of investment company, legally classified as a closed-end fund, that periodically offers to buy back a stated amount of shares of the fund from the investors at the original Net Asset Value (NAV) at the time of purchase. Investors that buy interval funds are typically looking for high yields.

What to Know About Interval Funds Before You Invest

It's important to understand the interval funds are not the same as their fund cousins — mutual funds, closed-end funds, and exchange-traded funds (ETFs). As with any type of investment, interval funds have certain purposes that can be used to an investor's advantage or specific investment objective. However, used incorrectly, interval funds can be potentially disadvantageous.

Here's what to know about interval funds before you invest:

  • Interval Fund Repurchase Offers: At the time of purchase an interval fund will offer to repurchase a certain percentage of the investor's shares at set periods, called intervals, at a price equal to the fund's net asset value (NAV). The percentage of repurchase depends on the fund but typically ranges between 5-25 percent of the amount the investor's fund assets. This repurchase intervals are most commonly on a quarterly basis but can also be bi-annual or annual.
  • Interval Fund Liquidity and Selling Shares: Interval funds are not liquid, meaning they are not easily converted into cash. Just as the fund will offer to repurchase a percentage of the fund at intervals, the investor is limited to selling shares at intervals. 
  • Interval Funds vs Closed-End Funds: Interval funds are classified as closed-end funds but they're not the same. For example, interval funds do not typically trade on the secondary market and they typically trade at the fund's NAV, while closed-end funds do not share these qualities.
  • Interval Fund Holdings: One of the most unique qualities of interval funds is that they tend to invest in a diverse range of assets, which may not be held in other types of funds. For example, interval funds can invest in illiquid assets, such as farmland and forestry land, and other alternative investment types or securities, such as business loans and private equity funds.
  • Interval Fund Expenses: The expenses for interval funds tend to be significantly higher than open-end mutual funds, closed-end funds, and ETFs. Fees and expenses vary from fund to fund but you can expect to pay management fees of 1.5 percent and higher, service fees of up to 0.25 percent, and over 3.5 percent in annual fees. These costs are two to three times the expenses for most mutual funds and ETFs. Front-end sales charges, broker commissions, redemption fees may also apply to interval funds. 
  • Interval Funds Yields: The ability to invest in alternate types of assets and the ability to limit investor redemptions (withdrawals), creates the greater ability for interval fund managers to pay out higher periodic distributions to investors. Therefore investors may enjoy greater yields and higher potential returns than other types of funds. ​

Pros and Cons

Now that you know the basics of interval funds, you can determine if buying shares of this unique investment type is a good idea or not. Like other types of funds, interval funds have their advantages and disadvantages.

Here are the main pros of interval funds:

  • Higher potential yields than other fund types
  • Access to alternative type investments, such as business loans and private equity
  • Periodic offers from the fund to repurchase shares at NAV from investor

Here are the main cons of interval funds:

  • Not a liquid investment, meaning you can't redeem shares whenever you want
  • Expensive compared to mutual funds, closed-end funds, and ETFs

Bottom Line

Most investors can receive the most common benefits of investing with conventional mutual funds, which are classified as open-end mutual funds, and from ETFs. These benefits include diversification, long-term growth of principal, and income from dividends. If investors are looking for other qualities in a fund, such as higher potential yields or access to alternative investment types, interval funds may be appropriate.