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Matt Malone delves into the key differences between drawdown and semi-liquid funds.
Key Takeaways
- One of the primary differentiators between drawdown and semi-liquid funds is liquidity. In a drawdown fund investors commit capital for a set term without liquidity, while semi-liquid funds offer periodic liquidity, typically around 5% per quarter.
- Drawdown funds have predictable cash flow and managers can be more opportunistic about their investments. Semi-liquid funds have uneven cash flows, which means managers need to put money to work when it comes in, regardless of market conditions.
- It is critical to determine your liquidity needs before selecting a fund. Semi-liquid funds offer periodic liquidity but may require trade-offs in return potential, as they must maintain liquidity buffers and periodically adjust their investment approach.
Transcript
Today we're going to talk about funds. What kind of funds, you ask? Institutional drawdown funds versus semi-liquid funds. And I say institutional because these funds have primarily been structured for institutions in the past. So we get a lot of questions from clients about what are the differences between these two fund structures? What funds structures should they use to access private markets?
There are a number of different factors to consider. But I'd say that one at the top of the list is liquidity. The reason why many liquid funds exist is because the traditional drawdown funds don't provide a whole lot of liquidity for a long period of time, whereas the semi-liquid funds may provide some limited liquidity on a monthly or quarterly basis.
When you dive deeper into these funds and these fund structures, there's really two layers of liquidity. The first layer is investor liquidity. Meaning can I get my money out at any given time, or at a regular interval? And can I rely on that? And in the drawdown fund really the answer is no.
You’ve signed up for a certain term and your capital will be in that fund until that term is over and the manager can liquidate those investments. Whereas in a semi-liquid fund, there's usually agreement between the manager and investors as to some regular interval of liquidity, whether it's monthly or quarterly, and some percentage of the portfolio that will be available for liquidity typically is around 5% a quarter.
So that is an important consideration. But that consideration also impacts other aspects of the fund and the fund's life cycle. Importantly, the underlying investment liquidity, which is different than investor liquidity, but they're both related. So if you are a manager of a drawdown-style traditional fund, you don't have to think too much about liquidity other than at the very end of your fund life cycle.
You have investors commit to a certain amount of capital. You can pull down that capital over time as you see opportunities present themselves in the market, and investors are basically required to manage liquidity for you as you're waiting to put that capital work, which may allow you to be more opportunistic and to be more thoughtful about when you put capital to work, which could enhance returns.
Whereas in a semi-liquid vehicle, if you are a manager, you have less control over when the capital comes in. Usually it's monthly or quarterly. And when that capital comes in, if you want to maintain your return profile, you typically have to put that capital to work right away, regardless of market conditions.
It makes it easier for the investor. It could add some complexity for the underlying portfolio manager. It could also have an impact on the return profile. In addition, if you're the manager, you also have to think about what money is going out. And so you have to have some liquidity within your portfolio to fund that. So that will also impact what you invest in. So these are, you know, important considerations when you're looking at investment strategies.
You have to think about who your investors are, how much liquidity they're willing to tolerate, and what are they potentially willing to give up in order to have that more liquid structure?
And that's really the starting point. When you continue to dig in, there are other considerations like tax and suitability. But liquidity is a key one at the front end.
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