Introduction to private credit and public-private solutions

1.3 Accessing private credit in an interval fund

Accessing private credit in an interval fund

 

This video unpacks the workings of an interval fund, an investment vehicle that can bring periodic liquidity to illiquid assets such as private credit.

 

DVHB
David Bradin

Fixed income investment director at Capital Group

8MINVIDEO

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Strategizing with interval funds

 

Let’s walk through this brief example to help illustrate how you and your investors might strategize around interval funds.

Eric's investment

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Eric is looking to invest $1 million for the long term. His advisor thinks that public-private funds might be a good investment opportunity for Eric, given his desire for higher yields, his longer time horizon and his tolerance for less liquidity. Together, Eric and his advisor decide to invest his $1 million into the Capital Group KKR Core Plus+ fund.

 

You can learn more about this fund in other materials in this series, but what you need to know now is that this fund has a quarterly interval, and allows up to 10% quarterly repurchase requests of a fund’s outstanding shares under normal circumstances per interval across all investors (not per investor). Keep these details in mind for the remainder of Eric’s story.

 

Eric’s advisor is able to invest his $1 million on any day, at the fund’s NAV price. They don’t need to wait for the interval fund’s repurchase window to buy in.

This $1 million in Capital Group KKR Core Plus+ is not Eric’s entire portfolio. Eric’s advisor has allocated this investment as a part of Eric’s overall fixed income holdings. You can learn more about potential allocations of public-private funds elsewhere in these materials.

 

Five years after investing — A large repurchase

 

Over the next five years, Eric’s investment in the fund grows to $1.5 million due to a combination of his new contributions and fund growth.

 

After five years, Eric tells his advisor that he’d like to repurchase $250,000 from the fund. Since this is an interval fund, Eric can’t just redeem the money at any time. The advisor must submit a request to the fund manager in advance of the fund’s quarterly repurchase window deadline. The request is made and, assuming the total repurchase requests for the fund do not exceed the 10% of the fund's outstanding shares repurchase limit for the quarter, Eric is entitled to receive the repurchase amount of $250,000.

Notice that this $250,000 was more than 10% of Eric’s entire $1.5 million investment. As was stated earlier, the Capital Group KKR Core Plus+ fund allows for up to 10% of its total outstanding shares to be repurchased per interval. Eric was able to redeem more than 10% of his total investment holdings in the fund because that amount did not exceed the 10% repurchase limit of the fund's total outstanding shares. This illustrates that in certain situations, individual investors will be able to repurchase as much as they request.

 

This won’t always be the case, as we’ll see below.

 

Ten years after investing — A small repurchase request, with a catch

 

In another five years, let’s imagine that Eric has $1.75 million in the fund, due to growth and new contributions. At this point, Eric wants to request to have $150,000 worth of shares repurchased, which is less than 10% of his investment. Eric’s advisor submits this request in advance of the fund’s quarterly repurchase window deadline.

This time, however, the total repurchase requests from investors collectively add up to 20% of the Capital Group KKR Core Plus+ total outstanding shares, exceeding the 10% maximum. This means that all of the repurchases will be prorated to keep the total repurchase amount at 10% of the fund’s outstanding shares. Eric receives $80,000 instead of his requested $150,000. Even though his own request was below the repurchase maximum proportion of his investment, the fund’s total requests caused Eric’s requested repurchase to be prorated. Eric will need to make another request at a later repurchase window if he wants to withdraw more.

 

Fifteen years after investing — Eric cashes out

 

Five years later, Eric has a $2 million investment in Capital Group KKR Core Plus+ and decides to liquidate his entire portfolio. His advisor submits the request and, assuming all of the requested amounts of the fund's investors fall below the 10% maximum repurchase amount of the fund in totality, at the next repurchase window, Eric is entitled to receive his $2 million — a full 100% of his investment in the fund. Eric was able to have his entire investment repurchased at this window because other investors were not making similarly large requests at the same time, and Eric’s $2 million on its own was not a major portion of the fund, so total requests summed to less than the 10% maximum. Had repurchase requests exceeded 10% of the fund’s outstanding shares, Eric would have had to wait to fully liquidate.

Lessons learned

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Let’s review what Eric’s story illustrates about strategizing with interval funds:

  • Interval funds are better suited for longer-term investors. Eric was interested in investing his money for the longer term in exchange for a chance at higher returns than public fixed income investments over the same period. He did not make repurchase requests from the fund for years at a time. Periodic liquidity and limits on total repurchases mean that you and your investors must strategize around these funds with the knowledge that you may not be able to quickly shift your positions in response to new needs and economic developments.
 
  • Interval funds are defined by their periodic liquidity. Eric could not redeem his funds on any given day. His advisor had to make a request in advance of the fund’s quarterly repurchase window. When considering interval funds, be sure your investors understand that their holdings are not available for repurchase on demand, and strategize accordingly. Interval funds are better suited for investors without a need for immediate liquidity. Remember that different interval funds can have different interval periods.
 
  • Repurchase requests from interval funds are not always met in full. One of Eric’s requests to have part of his investment repurchased from the fund could not be fully met because the investors’ total requests exceeded the fund’s quarterly repurchase limit. Eric’s repurchase request was prorated based on the excess, even though his own request at that repurchase window did not exceed the fund-wide limit. As the points above emphasize, interval funds are better suited for investors who do not need very fast access to their invested money. As with the interval periods, keep in mind that different interval funds will have different repurchase limits to consider.
 
  • Periodic liquidity does not always mean that the money is “locked up.” Despite Eric’s one instance of a prorated redemption, he was also able to make two repurchase requests that represented more than 10% of his holdings in the fund. This 10% total repurchase limit applies to the fund as a whole, not to any one investor. Eric was even able to redeem 100% of his investment because the other investors were not making significant requests as a whole.

End of lesson

So far, this module has discussed private markets, private credit and interval funds. Don’t forget to review lesson takeaways here.

 

Continue to the next lesson to learn about public-private solutions, a category of product that combines all these elements.

NEXT LESSON

Introduction to public-private solutions

1.1 Introduction to private markets and private credit
1.2 Fundamentals of private credit
1.3 Accessing private credit in an interval fund
1.4 Introducing public-private solutions

Takeaway

Private credit 101:

Investing in private credit through an interval fund

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For financial professionals only. Not for use with the public.

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the interval fund prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
Consider the following risks for the Capital Group KKR fund(s) discussed in this material: The fund is an interval fund that currently provides liquidity to shareholders through quarterly repurchase offers for up to 10% of its outstanding shares. To the extent more than 10% of outstanding shares are tendered for repurchase, the redemption proceeds are generally distributed proportionately to redeeming investors (“proration”). Due to this repurchase limit, shareholders may be unable to liquidate all or a portion of their investment during a particular repurchase offer window. In addition, anticipating proration, some shareholders may request more shares to be repurchased than they actually wish, increasing the likelihood of proration. Shares are not listed on any stock exchange, and we do not expect a secondary market in the shares to develop. Due to these restrictions, investors should consider their investment in the fund to be subject to illiquidity risk.

Investment strategies are not guaranteed to meet their objectives and are subject to loss. Investing in the fund is not suitable for all investors. Investors should consult their investment professional before making an investment decision and evaluate their ability to invest for the long term. Because of the nature of the fund's investments, the results of the fund's operations may be volatile. Accordingly, investors should understand that past performance is not indicative of future results.

Bond investments may be worth more or less than the original cost when redeemed. High‐yield, lower‐rated, securities involve greater risk than higher‐rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. The fund may invest in structured products, which generally entail risks associated with derivative instruments and bear risks of the underlying investments, index or reference obligation. These securities include asset-based finance securities, mortgage-related assets and other asset-backed instruments, which may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market's perception of issuer creditworthiness; while generally supported by some form of government or private guarantee, there is no assurance that private guarantors will meet their obligations. While not directly correlated to changes in interest rates, the values of inflation-linked bonds generally fluctuate in response to changes in real interest rates and may experience greater losses than other debt securities with similar durations. The use of derivatives involves a variety of risks, which may be different from, or greater than, the risks associated with investing in traditional securities, such as stocks and bonds. For example, the fund may purchase and write call and put options on futures, giving the holder the right to assume a long (call) or short (put) position in a futures contract at a specified price. There is no assurance of a liquid market for any futures or futures options contract at any time. Investing outside the United States involves risks, such as currency fluctuations, periods of illiquidity and price volatility. These risks may be heightened in connection with investments in developing countries.

The fund invests in private, illiquid credit securities, consisting primarily of loans and asset-backed finance securities. The fund may invest in or originate senior loans, which hold the most senior position in a business's capital structure. Some senior loans lack an active trading market and are subject to resale restrictions, leading to potential illiquidity. The fund may need to sell other investments or borrow to meet obligations. The fund may also invest in mezzanine debt, which is generally unsecured and subordinated, carrying higher credit and liquidity risk than investment-grade corporate obligations. Default rates for mezzanine debt have historically been higher than for investment-grade securities. Bank loans are often less liquid than other types of debt instruments and general market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy.

Illiquid assets are more difficult to sell and may become impossible to sell in volatile market conditions. Reduced liquidity may have an adverse impact on the market price of such holdings, and the fund may be unable to sell such holdings when necessary to meet its liquidity needs or to try to limit losses, or may be forced to sell at a loss. Illiquid assets are also generally difficult to value because they rarely have readily available market conditions. Such securities require fair value pricing, which is based on subjective judgments and may differ materially from the value that would be realized if the security were to be sold.

The fund is a non-diversified fund that has the ability to invest a larger percentage of assets in the securities of a smaller number of issuers than a diversified fund. As a result, poor results by a single issuer could adversely affect fund results more than if the fund were invested in a larger number of issuers. The fund intends to declare daily dividends from net investment income and distribute the accrued dividends, which may fluctuate, to investors each month. Generally, dividends begin accruing on the day payment for shares is received by the fund. In the event the fund's distribution of net investment income exceeds its income and capital gains paid by the fund's underlying investments for tax purposes, a portion of such distribution may be classified as return of capital. The fund's current intention not to use borrowings other than for temporary and/or extraordinary purposes may result in a lower yield than it could otherwise achieve by using such strategies and may make it more difficult for the fund to achieve its investment objective, than if the fund used leverage on an ongoing basis. There can be no assurance that a change in market conditions or other factors will not result in a change in the fund distribution rate at a future time.
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