Show V/O:
This is Alternative Allocations by Franklin Templeton, a monthly podcast where we share practical, relatable advice and discuss new investment ideas with leaders in the field. Please subscribe on Apple, Spotify, or wherever you get your podcast to make sure you don't miss an episode. Here is your host, Tony Davidow.
Tony:
Welcome to the latest episode of the Alternative Allocations podcast series. I'm thrilled to be joined today by Kim Flynn, one of the real pioneers in the growth and the evolution of evergreen funds and the private markets. Welcome, Kim.
Kim:
Thank you so much for having me.
Tony:
And, Kim, you've been one of the real significant voices and really chronicling what's going on with the growth of interval and tender offer funds, what we typically refer to is evergreen or perpetual funds, and you just come out with your latest report, which is really telling us where the industry has evolved.
What does the report tell us about the growth of the market today, both in its size and its diversity?
Kim:
We're at the point where there's over 300 funds. So I think a lot of financial advisors are grappling with, on one hand, a lot of options, a lot of good choices, but you're trying to decide the best firms and the best strategies to diversify your portfolio. In the 10 years that we've been doing research on the interval fund marketplace, it's the first time that advisors have had to grapple with that because the market has been growing at about 25% compounded annual growth.
We've really got a lot of new entrants that are going to be coming into the marketplace, creating even more choice. I think that leaves advisors, on one hand, excited because there's so many new private market strategies and we're seeing more than just what we saw in the early days in terms of private equity and private credit. We're seeing some really innovative tech-focused funds, for example, and I think there'll be a lot of new funds coming that are going to explore some of that white space.
Tony:
Kim, maybe just take a little bit of a step back. So, your firm, XA Investments, you have done a tremendous job in researching and sharing research on how it's been growing, both in the size and the diversity and you mentioned some of the numbers which I think is exciting. Why did you get started in doing this and what sort of research are you really focused on? Talking about the wealth channel, I think that's an important segment for us.
Kim:
My entire career has been focused on SEC-registered closed end funds. An interval fund is one type of a SEC-registered closed end fund. In the 25 years that I've been focused on this space, most people didn't really care and there were more niche strategies and niche fund managers pursuing this part of the market.
I spent the early part of my career at Nuveen Investments and Nuveen is well known in the market as a listed closed end fund leader. It's a sister fund structure to the interval fund market. So, by way of background, we started thinking about interval funds in about 2010.
This was after the great financial crisis, and we were thinking we were always looking at differentiated investment opportunities. And at that time, we were looking at currencies, commodities, a lot of the liquid alternatives as I can imagine other firms were doing. I think that a lot of advisors were disappointed in things like currencies and commodities.
At Nuveen at that time, we started researching private markets and including those in the mix – combinations of public and private. So when I left Nuveen to found XA Investments, we were trying to open up access at a time in 2016 where it was still probably pretty early. So our database goes back longer than any other research firm because we were following the space when there were just a handful of managers and a handful of funds.
So we've been able to witness the innovation and the growth in the market. And through the work that we do on the research and consulting side, we talk with pretty much anyone that wants to understand these trends. And so we get a lot of insights into new fund formation, what's coming. And that's exciting. And we try to share that with people who follow our research.
Tony:
So if we go back to 2016, I think the early adopters were private credit managers. The structure had been in place. But I think interval and tender offer funds kind of evolved to a way of providing exposure to illiquid investments. Private credit were the first foray and a lot of the early growth was private credit. But talk a little bit about how the growth is diversified out. You mentioned private credit and some of the more niche strategies coming to the market.
Kim:
I think that private credit is always going to be a dominant part of this market. I think for many fund sponsors, private credit is the first foray into the interval fund marketplace, partly because it's easier to get to a daily NAV on private credit. There's a wide liquidity spectrum when you're talking about credit instruments.
Therefore, these products are also sold often using yield or distribution rates. So many of the private credit funds in the early days post launch, you're able to talk with advisors. And most of the funds, the yield is indicative of the return over time.
So therefore, it's easier to sell for many fund sponsors. So private credit right now is about half the market. It's the one area of the market that we're concerned about saturation because you've got a lot of choice between direct lending, asset-backed, structured credit. And then there's a big handful of multi-strat credit.
But there are a lot of opportunities, a lot of growth potential in private equity and beyond. The more illiquid the strategy, so talking about private equity or infrastructure, sometimes the structure itself is not as user-friendly for financial advisors. It's harder to get to a daily NAV. Many of the private equity and infrastructure funds are actually structured as tender offer. There's some trade-offs as we explore some of these other areas of the private markets.
Tony:
We've had guests on our program and we've talked about drawdown an interval and tender. It's not necessarily one or the other, but it definitely seems in the wealth channel, it's easier for advisors to scale evergreen funds across their whole practice, where drawdowns are typically limited to a subset of their practice. So it seemed like the interest in the evergreen structure is growing and growing over time.
We certainly talked to advisors all day long about it. And there are some firms that they're only doing evergreen funds. But from your vantage point, you're also talking to managers. It seemed like one of the exciting things to us is the quality of the manager bringing product to the market who historically had been hesitant to bring products to the wealth channel. I think the structure is a big part of that discussion.
Kim:
We talk about the expansion in terms of product for everyone, high-end middle of the road in terms of wealth. And then we have a lot of products being built for the mass affluent customer. Part of that, we are seeing what we call an upmarket trend, meaning sophisticated alternative boutiques who are going to be charging performance fees, typically performance fees or a signal.
I think it's a signal of quality sometimes, only because the firms sometimes they have capacity constraints. Sometimes they have institutional fee schedules where they're not going to drop price just to go into the private wealth marketplace. But I think, Tony, you're right, there's an expansion of this market.
And the new entrants are picking their point of distribution and they're choosing slightly different audiences. So five years ago, I think the average interval fund was built for high net worth or ultra high net worth customer. And the focus was largely on the RA community.
And I think now, as we see more traditional investment managers, large, multi-channel, they're thinking about how do we address the needs of more than just the RIA customer. So there really is an expansion of the market beyond what it was originally focused on. And I think that's okay.
I think we'll see differentiated strategies, different price points. And then we'll also probably see some capacity limits. And that's okay too, because I do wonder with a lot of the larger interval funds in the market, at some point, you start to question how much capital can be deployed. And that's an appropriate conversation that financial advisors should be having about what are the expected returns given the capacity that you have. I think as we see more up market capabilities and managers come, those conversations will change a little bit depending on what's being offered.
Tony:
And I want to pick up on something you say, because I often get from advisors, are these watered down versions of the drawdown structure. And one of the things that we've heard consistently on the podcast, speaking to both CIOs of multifamily offices and outsourced CIOs, who are allocating capital to endowments and foundations, they often use both. They actually believe that the evergreen structure and the drawdown structure can serve as a complement to one another.
So they definitely don't view it as a watered down version. But again, to your point, they do appeal to the masses. So they're getting a lot more play and a lot of the wealth distribution channels where they couldn't really efficiently access drawdowns across their entire book of business.
Kim:
I think it's the right question to be concerned about, are we getting the good stuff? Is this going to have the alpha potential that the existing institutional strategy has? As we see more products, I think that question is going to come to mind for advisors.
To date, we've seen these funds perform as expected. But I think it's going to be a continuing question that we've got to think about as we move forward. Because if we just look at private credit, the private credit part of the market has really benefited from higher interest rates.
So therefore, they're easily beating their benchmarks, which might be the high yield market, the loan market is going to be a question going forward about if the strategy is watered down or if the liquidity basket is too large. Because liquidity management is really a central function for an interval fund. You've got to be ready to provide the liquidity. In addition to having a strategy shift, you also need to think about how much is there a return drag associated with that liquidity piece. There will be differences clearly in an interval fund, but we don't want things being labeled as watered down.
Tony:
I'll just take a more macro perspective on this. We just came out with our 2026 outlook. And we have been talking about for the last two years that we do think there'll be a larger dispersion of return between managers who have managed their good times in bad, with deep and dedicated resources versus those that are newer.
So it's not necessarily the structure itself that is problematic. It might be managers newer to the space who lack the resources. We have definitely gone through an environment of significant change from easy money and ‘21 and money just going to the moon to a changing rate environment, high inflation.
And to your point now, as the market gets much more mature, especially in private credit, we suspect we'll see larger dispersion between the winners and the losers. But I don't know that I’d pin that on the structure as much as I do it's the managers may be lacking the expertise because in the discussions we have with managers, that is one thing they need to be comfortable with, that they can deliver a similar experience in a structure like that.
Kim:
Agreed. That's really the true test. So in our research, we talk about 50% of the market has greater than a three-year track record.
Most funds don't have much track record to be able to evaluate. In the last few years, products have been sold on yield because that's sort of a known figure in the early days. But going forward, they will be judged based on those five-, 10-year track records that have yet to develop.
There are a handful of market leaders that have more track record. And as we see interval funds being incorporated into models or being added to platforms, it is no surprise that the bias is going to be to managers that have demonstrated the performance that you're talking about. You've got to look at five-year, seven-year, 10-year track records.
And a lot of new managers are going to be behind, I think, in terms of some of those opportunities like models, because those fund specific track records are not there yet.
Tony:
And it's a perfect segue into something that you touched on earlier, which is really the focus of what we're doing is trying to help advisors make better informed decisions. And to your point, with so many funds, so many choices out there, the biggest challenge I hear from advisors is, how do I winnow that down to a manageable universe? How do I make sure that I understand two funds that may sound very similar?
I understand what sort of bets and biases are kind of built into that. So due diligence becomes one of the challenges. I'm spending a lot of my time with advisors on that, but I'm curious, it sounds like that's a big part of your discussion as well.
Kim:
We do too. We've started screening based on custom criteria that advisors give us, because while we don't put our database out there, we do have interval fund indices. So if you want to see funds with track record, funds with sufficient liquidity, you can look at our index to see a good list of funds that are going to be evaluated first by gatekeepers and platform managers.
For advisors looking for shortcuts, it's helpful to zero in on the strategy of focus. And then when we run these sorts for advisors, the reality is there's only three, four, or five funds that often meet the criteria. If you are thoughtful about what your investment committee is going to be comfortable with, I think it surprises a lot of advisors when we take the 308, which is the total number of funds, and get it down to a very short list that meets their criteria.
Sometimes it's a track record requirement that with 67 funds launching in 2025, 50 funds launched in 2024, there's a lot of funds that are brand new. And as you know, these funds, there's a soft launch period that takes a long time for them to sort of mature. In some ways, it may feel overwhelming given the growth in the space and the number of funds.
I think that if advisors are very thoughtful about their criteria, you can focus in and zero in on the right interval funds to be added.
Tony:
Our teams are definitely interfacing with headquarters at a lot of the major firms out there and working through the iCapitals in the CAIS’s of the world to help winnow that list down and oftentimes they're looking at institutional track records, the depths of resources and all of that. I think it's a little daunting for advisors, but I always encourage them, if you can't get comfortable with what they're doing and understand how they're generating the return, if somebody hasn't done the due diligence, you can always pass because there are a lot of funds out there. But I do think it is a challenging thing.
And I know one of the things that you've been doing is writing a lot and helping people think through valuations and methodologies and all of that. Any sort of words of wisdom as advisors kind of think through as they're starting to really incorporate this more broadly in their practice.
Kim:
We will favor fund sponsors who are very upfront in talking about how they manage liquidity, how they're going to meet the redemption requirements. We like it when fund sponsors up front set appropriate expectations with their clients in terms of coming in. So I think in the early days, many interval funds were sort of miss-sold as being semi liquid.
These are closed. They have a 5% quarterly liquidity. But if everybody wants liquidity, then everybody is going to be frustrated if you're in the line trying to exit a fund. That becomes problematic. And so setting the right investment horizons and in the sales and marketing practices, these are complicated product pitches. I get it. It's hard to explain a private credit strategy in five minutes or less and then let alone talk about some of the structural limitations.
But in the long run, I mean, we try to be advocates for the interval fund market. And one of the questions that I get all the time is, has this market been stress tested? And the reality is, no, it hasn't, because most of these funds were not around in the great financial crisis. And in 2020, we had a very quick recovery. Most funds did not have to meet multiple quarters of redemptions.
Advisors need to be thinking about using interval funds appropriately and have the right sort of expectations. Because like a private fund, you're not going to be able to pull your money out any given Tuesday. Now that I think salespeople don't have to spend their whole time explaining what the heck an interval fund is, you can get into more of the meat of how these work and what are the pros and cons.
I think that's good for the industry. And in the end, you want people in your fund that are committed to if it's infrastructure, they may need to have a five-year time horizon for that. I think we'd like to see more sales and marketing practices that line up with setting those sort of expectations on the front end.
Tony:
I'm smiling because I don't like the term “semi-liquid” because I think it sets an expectation that you can get out of funds. And I always think of that liquidity provision is really a safety valve if there's a change of circumstances. If you want to capture that long-term illiquidity premium, you need to think of these as long-term investments. And we should just be upfront and honest with people about that in the beginning.
Much of our work, whether it's the podcast or the book that I wrote, or the white papers that I publish or the speaking I do around the country, we're trying to help advisors make those better informed decisions. We embrace illiquidity. We expect that that's something that is a challenge for them and ultimately a challenge for their underlying investors.
But understand illiquidity is how you get that exceptional experience over the long run. And if you don't have that long-term mindset, you're likely to be disappointed along the way. So it's kind of built into the fiber of all that we talk about.
Kim, I'd love for you to maybe help size the market for us a little bit. So you said there's 300 funds or 308 funds in the marketplace. Half of those are private credit. It's been growing at a 25% CAGR. But what does it look like? We're getting the biggest and best players coming to the market it seems like almost every day. How diverse is it? Is it more private equity in the pipeline, more infrastructure in the pipeline? What are you seeing and what are you hearing is kind of on the horizon?
Kim:
So I think one thing that's encouraging about the interval fund space is that there's a lot of diversity, diversity by manager, meaning unlike the REIT marketplace or the BDC marketplace, which tends to be concentrated in the top five managers or so, here about half the assets in the market are in the top 20 funds. You do see some concentration, but every quarter that goes down. So there are funds that have a first mover advantage in the marketplace, but this market is diversifying.
The market's still open to new entrants, though, too, in a way that I think if you were trying to launch a non-traded REIT or non-traded BDC, you'd have to raise significant seed capital to get to market. Interval funds are being launched with initial capital or seed capital, but there's still plenty of opportunity. In terms of asset class diversification, private credit, beyond that, number two, in terms of funds and assets would be private equity.
Private equity surpassed real estate about a year and a half ago. We used to have, in terms of assets, more assets in real estate, but now private equity growing very, very quickly. I think a lot of advisors want a point of entry for private equity that's not a private fund, because there are very limited choices right now in venture capital.
Private equity surpassed real estate about a year and a half ago. We used to have, in terms of assets, more assets in real estate, but now private equity growing very, very quickly. I think a lot of advisors want a point of entry for private equity that's not a private fund, because there are very limited choices right now in venture capital.
Beyond that, we're actually seeing a growth in hedge funds. Twenty years ago, in addition to the credit funds that were around, there were a ton of hedge funds. Hedge funds had been out of favor. In the last two or three years, though, we've seen some strong performance. We're actually seeing new hedge funds launch, multi-strat type strategies. So that's kind of curious.
Within real estate, even though the real estate private equity is a bit out of favor, we've seen growth in infrastructure with remaining concerns about prices and inflation made total sense. So that was the headline in ‘24, was the growth of infrastructure funds.
This year in ‘25, it's actually been asset backed as an alternative to the corporate credit concerns. And that's kind of interesting.
I think what we'll see going forward is some more sector specific. We had a couple of tech capital raises, innovation, AI-focused. Going forward, I think we'll probably see more, maybe like a health care fund. We did see an energy fund filing. It's kind of surprising, thinking back 10 years ago, 15 years ago, there were a ton of energy products on offer. The interval fund space literally does not have an energy or energy transition.
So we're going to see more of that. And I think that's just because we're in the end of the third inning, probably in terms of where there is white space left. Most new fund sponsors, they just don't realize how many competitors they do have, either direct or indirect competitors. But with some of these spaces, there's literally nothing there.
It's not quite the ETF market, where you have to be the first mover. You could be the second or third into that space and have another source of competitive edge. But I do think we're going to see continued expansion, not just in private credit, of course, private credit will continue, but there'll be a lot more fun launches in the hedge fund space, in energy, and some of these other sectors.
Tony:
And you have such a unique vantage point. We were talking before we started the podcast about where the opportunities are and certainly the marketplace we're starting to see private public partnerships, some success, probably more noise than actual flows there. And then, of course, we're hearing a lot about model portfolios. And again, I think the interval structure is much more conducive for models than the first generation of fund, which definitely didn't fit or work very well.
So are you seeing traction there? And what do you think about the opportunity?
Kim:
I think it is early days for the public private partnerships that we've seen. There's only been a couple of funds launch. There's a lot of headlines around these partnerships, but some of those products have not even launched yet.
For many traditional investment managers, they see this excitement and the growth of the interval fund space. A lot of those firms have spent the last five years figuring out their active ETF expansion plan. And so they're moving into thinking about interval funds.
So it's natural for them to think about a public-private partnership if they don't have the private market capabilities internally. And I would just caution that when we're mixing public and private, we start to create problems for the advisor when we're thinking about implementation, because these advisors already have high-yield exposure. They already have public equity exposure.
So the question is, what's the rationale and where is it going to fit in the portfolio? You do need some liquid or semi-liquid securities to meet redemptions. But I have a hard time understanding where 50-50 public-private products fit.
So I think there might be a more elegant way to combine public-private. But I think the business goals of a lot of these firms are going to drive product that we see launched. So it's not necessarily solving an investment problem.
That'll get compounded to the extent you would try to put one of those products into a diversified model to the extent that there's too much public exposure overlap. There's a lot of conversation right now about models, implementation. But there's rebalancing challenges when it comes to interval funds, because you can only get so much liquidity and every shareholder is treated the same with respect to liquidity.
So I think there's more to come on that. I think we'll see a second and third wave of public-private partnerships. So hopefully those products are more thoughtful when it comes to some of these challenges that advisors are going to face.
The main rationale that I've heard for the public-private partnerships is broadening the buyer base. And that could be. There are plenty of advisors who don't use interval funds today. So I think that's the hope for some of the platform managers who are contemplating public-private mixes.
Tony:
Well, Kim, thank you for your insights. This has really been terrific to hear where we've been. And maybe more importantly, where we're going.
This is an exciting time. We will certainly follow all of your great research. You're very visible on social media, so I suspect our audience, if they're not following you, will be following you in the future. Thank you so much for joining us on the Alternative Allocations podcast series.
Kim:
Thank you very much.
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