When exploring a registered-fund adaptation, avoid these all-too-common roadblocks
By Terry Gallagher (pictured), EVP, Director of Fund Accounting & Administration, UMB Fund Services – When private equity managers decide to adapt an existing strategy from a partnership to a registered-fund structure, they may run into roadblocks – and wish they had considered some key issues earlier in the process. Below are the most common issues, based on my work on fund-formation with private fund managers.
Usually, private fund managers seeking a public fund structure are exploring either interval or tender-offer structures, since traditional open-end mutual funds are limited to investing a maximum of 15% in illiquid assets and must offer daily purchases and redemptions.
Structurally, interval funds and tender-offer funds work the same way. Here are highlights on what sets them apart—and can make them similarly challenging for managers.
Purchase and repurchase timing. An interval fund typically offers purchases daily, while tender offer funds offer purchases on a monthly or quarterly basis. Both offer repurchases, but interval funds are defined in their offering documents with specific timing and the amount that they will take, while tender offers have more flexibility in the amount tendered and the timing of those tenders.
Practically speaking, managers sometimes hope to offer an interval fund structure but run into a roadblock because the industry still primarily requires interval funds to be valued on a daily basis.
Investor appropriateness. Both interval and tender-offer funds can be offered to retail or accredited investors, but what really drives the decision between the two is the type of investments being offered inside of the vehicle and whether there’s going to be a performance fee. Basically, if the underlying investment itself would only be available to accredited investors, then the fund itself would only be available to accredited investors.
Also, only accredited investors can invest in a fund that has a performance fee. Retail funds can only have what’s called a fulcrum fee, which is a fee that goes up and down depending on the performance of the fund.
Tax considerations. Many investors strongly prefer receiving a 1099 to a K-1; that’s a definite part of the appeal of this product category. But to issue 1099s, a fund must qualify under the Regulated Investment Company requirements of the IRS Code. Many managers come to us wanting to issue 1099s but then need to go the K-1 route because of their underlying investment strategy, which may not qualify under rules for tax diversification and “good income” tests.
In a recent post on the UMB blog, I included a table comparing attributes for interval and tender-offer funds across four key areas: advisor, investor, fund and audit. For reference, this table also compares and contrasts traditional mutual funds and private funds. You may find that compilation helpful – especially as a way to help avoid going too far down a road only to hit an all-too-common blockage.
Terry Gallagher oversees UMB Fund Services' registered fund accounting, administration and tax functions. He has more than 30 years of mutual fund industry experience.