Interval Mania

Today's post will be a little more fun than yesterday, starting off with interval funds. We've touched on them a few times and the short version is they are expensive, there are issues with how the funds (don't) mark to market and liquidity is very limited, often only 5% of the fund can be sold on just a quarterly basis. If someone really needed out, it could take a very long time. With that lead in, what's not to love?

I didn't realize but there have been more interval funds listed in the last five years than the previous 27 (hat tip to Meb Faber). Interval Fund Tracker is good resource for data. Ben Johnson from Morningstar posted this table on LinkedIn.

The primary investments available through interval funds these days are alts, mostly private credit and private equity. There are also interval funds that invest in infrastructure. 

Like many things, I am not likely to do much with private equity or private credit in an expensive, illiquid wrapper but I do think advisors should spend some time learning about the product. First off, clients might ask and I think an advisor should be able to comfortably be answer reasonable questions. I wouldn't expect an advisor to know much about Malaysian palm oil yields off the top or Egypt's trade balance with Switzerland but there's enough attention on interval funds and Bitcoin that having something to say is a reasonable expectation. 

Now, I would highly encourage finding an hour over the weekend to listen to this podcast where Meb Faber hosted Kim Flynn from XA Investments. After listening to the podcast, I am convinced that there is nothing about interval funds, closed end funds and tender funds (like closed end funds but without ticker symbols) that Flynn doesn't know. XA has an index of interval funds that is made up of 76 ( I think that was the number) interval funds that set a daily NAV. Two of the three largest funds in the index are from Cliffwater who we've looked at once or twice before. XA also manages two closed end funds and its own interval fund.

The other part of my interest here is that this wrapper will evolve. That was obvious about ETFs back in the 90's and it is obvious about interval funds now. That is not to say they must evolve to be more useful than they are now, I don't know but they might. One quick topic that came up in the podcast was that the wrapper might lend itself to investing in farmland. Trying to figure out a way to invest in farmland through a brokerage accessible product is something I spent a lot of blogging time on 20 years ago. 

There were quite a few stocks, a lot of palm oil plantations in Asia and a few other things, back then and as fun as it was to learn about some of those farm companies, putting client money in was not something that made a lot of sense. There are some stocks that are US traded that are in farming one way or another but the returns are low, the volatility is high and while the correlations to the S&P 500 tend to be low, they aren't reliably low. 

I've never stopped being interested in this idea, maybe the interval format will be the way to do it, I have no idea if or when but given my interest, it is worth keeping tabs on this. 

A quick pivot to a Barron's article where different advisors shared how they are "navigating Trump 2.0." One advisor talked about using managed futures and market neutral, "we took the allocation equally from equities and fixed income." That of course is the argument that the ReturnStacked guys make for using their funds. They say that their funds allow for adding managed futures without having to take away from stocks or bonds. 

The predecessor name to that strategy is of course portable alpha, using leverage to add a source that might/hopefully add alpha to a portfolio. I have been both fascinated by and skeptical of their funds but the concept is worth continuing to explore. As opposed to using leverage to blend different assets or strategies in one fund, I generally think using a fund that leverages up just one asset might yield better outcomes. The following is similar to an example we looked at once before using the Simplify Short Term Treasury Futures Strategy ETF (TUA). 

The way the leverage works, a 20% weighting to TUA should equal the result of 100% in US Treasury Two Year Note ETF (UTWO).

You can decide for yourself whether that's close enough to ever use TUA in this manner but it is certainly close enough for blogging purposes. 

Portfolio 1 with UTWO is unleveraged and Portfolio 2 with TUA is leveraged. The leverage lets us make additional room for the RISR/MBB pair we've been looking at lately.

The allocation similarities between Portfolios 1 and 2 certainly backtest very well and maybe I am not putting it together very well but I am not sure the extra 92 basis points of annualized growth is worth the added complexity of the leverage. Am I thinking about it incorrectly? Please leave a comment if you think I have it wrong.

UTWO is a few months older than TUA. UTWO's largest drawdown was just over 2%. As long as TUA continues to "work," if UTWO drops 2% then TUA should be expected to drop 10%. But weighted in the manner I've done in the backtest, the impact to the portfolio should be the same 50 basis points.

The largest drawdown for iShares 1-3 Year Treasury ETF (SHY), as close of an older proxy I can think of, had a 5% decline at its low in 2022 just before TUA started trading. If that large of a decline happened to UTWO at some point, then TUA would probably drop 25% but again the impact would be the same if TUA was weighted properly. I am unsure if with a decline that large for TUA, there would be a volatility drag effect where it might deviate from UTWO. That's the risk. Is that risk worth the extra 92 basis points?

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.