Interval funds are a form of mutual fund wherein the fund house permits to purchase or sell the units during a specific pre-decided time period. These funds are invested in both equities and debt securities but are mostly invested in debt instruments. It is a kind of closed-end fund with shares that do not trade on the secondary market. Alternatively, the fund periodically offers to buy back a percentage of outstanding share at Net Asset Value (NAV).
Mode of Operation
Interval funds supply the perfect blend of both closed-end funds and open-end funds. The functions of Interval Funds are similar to fixed maturity plans. Here, the money remains invested for a fixed tenure and the investment cannot be redeemed before maturity. The fund manager of such funds is authorised to utilize the investments. The manager allocates the money in securities for a tenure that matches the fund’s maturity. This facilitates the creation of a robust investment strategy that provides better returns.
Features of Interval Funds
Given below are the features of Interval Funds:
An interval fund can be invested in both equity and in debt. Nevertheless, it mostly invests in debt instruments.
The units belonging to an interval fund can be bought and sold only during certain intervals, as it does not furnish much liquidity to investors. Therefore, an interval fund cannot act as an emergency fund. Due to this illiquidity, the manager of an interval fund is authorised to invest in securities that have tenures in parallel to the fund’s maturity period and provide better returns to investors.
The expense ratio of an interval fund is usually higher than other mutual funds.
An interval fund mainly invests in debt securities and has a low-risk investment instrument.
Applicability of Interval Funds
The standout feature of interval funds is its investments in illiquid assets that are not listed on exchanges. These assets can be on the form of forestry tracts, private assets, commercial property and business loans. Investors with short-time financial goals and who are willing to take low to moderate level of risks may make investments in Interval Funds.
Taxation of Interval Funds
The taxation of interval funds is based on how much of its assets are being invested in equity and debt. If a minimum of 65% of an individual’s assets is invested in equity and equity-related instruments, it is either taxed similarly to an equity fund or as a debt fund.
Limited Selling Opportunities
As per the regulations, interval funds periodically offer to repurchase shares of the fund as stated in NAV. The repurchase period could be on the frequency of every three, six and twelve months. Most funds offer to repurchase on a quarterly basis. The individual is not provided with the guarantee of redeeming the number of shares during a given redemption; therefore repurchases are done on a pro rata basis. Due to the restricted selling opportunities, an interval fund has to be considered as a long-term option, most preferably an illiquid investment.
Merits and Demerits of Interval Funds
Here are the merits and demerits of Interval Funds.
Merits of Interval Funds
- The returns on interval funds are notably higher than that of open-ended mutual funds.
- The illiquid, long-term structure of interval funds assists in restricting normal investor ‘buy high/ sell low’ behaviour.
- Interval funds furnish retail investors with access to institutional-grade alternative investments with comparatively low minimums.
- Funds are less volatile and market reactive since investments are not tied to equities.
Demerits of Interval Funds
- Interval funds are illiquid when compared to open-end mutual funds.
- The repurchase is done on a pro rata basis, therefore there is no guarantee for redeeming all the shares during a redemption window.
- Since the yields are higher, so are the fees (which are higher than open-end mutual funds).
- The minimum investment that is low by private equity standards is high when compared to the minimum for open-end mutual funds.
- There is both a transparent and conflict-of-interest issue as the portfolio manager is permitted to invest in other funds of the fund sponsor.
Factors to be Considered by an Investor
Risk: Interval funds are not of great assistance during an emergency. They are entirely illiquid and there are no secondary markets where it can be redeemed. Even if an investor is prepared to pay the exit load, he/ she cannot make the exit before or after the specific time period.
Returns: Interval funds are not considered to be the best instruments when it comes to returns. In India, most interval funds provide an annualized five-year return of 6% to 8.5%. These returns, when translated to shorter periods, are found to be very low when compared to other types of funds.
Investment Horizon: Interval funds are targeted in achieving short-term goals. Investors whose investment horizons is equal to the maturity dates of interval funds may invest in them to earn short-term returns. An individual has to have concrete goals to utilize a huge sum for which interval funds provide upon maturity.
Financial Goals: Since interval funds are fixed income schemes, it is opted by investors who are not sure about the investment tenure. It can also be opted by investors who are looking for lump sum amounts at a predetermined time. Investors can achieve this by matching their horizon with the time interval at which redemption is permitted. Moreover, since it is mostly debt-oriented, it does not provide very high returns, and these funds are appropriate for investors with low-risk appetite.
Tax Implications: Interval Funds are taxed on the same vein as other mutual funds based on the quantum of investments in debt or equity. If a minimum of 65% of the portfolio is in debt, it is considered as debt funds and if the same proportion is is in equity, it is considered as equity funds for tax purposes. Since most of the interval funds are practically debt-oriented, Long-Term Capital Gains tax will be applicable (when the fund is held for more than 36 months). Long-term capital gains are taxed at the rate of 20% with indexation benefits. Indexation permits investors to be taxed on returns that are over and above the inflation rate by making adjustments for the purchase price of the securities for inflation. The Short-Term Capital Gains form part of the income and are taxed according to the income slab.
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