Choosing a semi-liquid private debt fund in a fast-growing market 

Since the market is relatively new, there is generally an absence of long-term track records from which to benchmark the different offerings. With the flood of new funds showing no signs of abating, the challenge of assessing funds with short-track records that are untested in different market conditions seems set to continue. 

Investors may need to rely on the manager’s track record of managing closed ended funds, which often use the same team and investment process as their open-ended fund. Thus, selecting a semi-liquid fund requires expertise in assessing closed-ended funds and the ability to factor in any differences that will inevitability arise from the open-ended format as well as understanding how the firm’s allocation policy applies to different funds, which may impact access to the General Partners’ best ideas and returns. We believe a manager’s open-ended fund should have access to the same deals alongside the closed-ended fund.

Semi-liquid funds face a valuation challenge that other fund types do not. Funds which invest in publicly traded securities can use transparent valuations obtained from the market, while closed-end funds produce valuations that are not used for subscriptions / redemptions, so if incorrect there is no risk of a dealing loss.

With semi-liquid funds, it’s necessary to value private non-traded investments and investors will subscribe or redeem from the fund based on these valuations. We see managers apply different approaches to valuations, whether produced in-house or outsourced. Investors should therefore carefully consider how valuations are produced, who has responsibility for them, and how conflicts are managed should they arise. 

Managers of semi-liquid funds need to ensure that they can meet their liquidity obligations. How different funds achieve this varies considerably. Some funds will hold cash or liquid proxies such as high yield bonds, while others will seek to hold shorter-duration private assets. Most will have the option to use debt to some extent, which can help with short-term liquidity needs but at a cost. Other firms may plan on selling holdings when cash is required, which might require a sale at an inopportune time at a discount, while most managers will plan to have, at least to some extent, regular distributions from vintage / maturity diversification.

The approach taken by the manager can potentially have a significant impact on fund returns and risk profiles, as well as the ability for the manager to sustainably meet its obligations. It is important to assess whether the manager has credible expertise and resources in both liquid and illiquid markets.

Gating is a concern for investors, but ultimately, it’s a protective mechanism rather than a risk. Gates protect investors in the event of large redemption requests that would negatively affect the value of the portfolio. But ultimately, in a single-manager model, if the fund ‘gates’, then investors cannot access their capital.

Typically, semi-liquid funds have a monthly or quarterly gate, with most funds limiting redemptions to 5% of the fund per quarter. If the gate is triggered, to protect investors, the proceeds are usually paid out pro rata. Investors should consider how the pro rata is applied as there are different approaches. Some funds pro rate based on the redemption amount. Other funds pro rate based on the investor’s total holding. While there is no right or wrong approach, with the latter approach all investors can reasonably expect that they should receive at least 5% of their holding each quarter (if they are looking to redeem), whereas with the first approach they can only be certain of this if they instruct a full redemption.

We often hear from investors that brand or reputation is a key consideration when selecting semi-liquid funds. We do not believe, however, that investors should conflate a strong brand with a well-managed fund. 

Relying on brand potentially means looking in the rear-view mirror when making selection decisions. There will be blind spots, and brand is based on past success. Investing in illiquid assets can take time to reverse, so forward-looking investment due diligence is essential to potentially minimize the risk of costly mistakes.