Trading Tomorrow - Navigating Trends in Capital Markets

How Interval Funds Are Opening Private Markets to Everyone

• Numerix • Season 4 • Episode 37

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Private markets are no longer reserved for institutional giants. In this episode, Kimberly Ann Flynn, President of XA Investments, joins host Jim Jockle to explore how interval funds and fintech innovation are unlocking access to private equity, private credit, and real asset strategies for everyday investors.

From inflation protection to diversification and income generation, Flynn outlines the benefits and risks of tapping into private markets, alongside the education, technology, and product innovation making it all possible.

James:

Welcome to Trading Tomorrow navigating trends in capital markets the podcast where we deep dive into technologies reshaping the world of capital markets. I'm your host, jim Jockle, a veteran of the finance industry with a passion for the complexities of financial technologies and market trends. In each episode, we'll explore the cutting-edge trends, tools and strategies driving today's financial landscapes and paving the way for the future. With the finance industry at a pivotal point, influenced by groundbreaking innovations, it's more crucial than ever to understand how these technological advancements interact with market dynamics.

Guest 1:

Today's episode is all about a fascinating shift in the investment landscape the rise of private markets. As companies stay private longer and high growth sectors flourish outside of public markets, private market investing is becoming a must-watch trend for institutional and retail investors alike. We're going to unpack why and how technology is accelerating this evolution. Joining us today is Kimberly Ann Flynn, president of XA Investments and a partner of the firm, where she leads all product and business development efforts. She heads up their proprietary fund platform and consulting work, and she's especially known for her expertise in closed-end fund product development. Kim is a regular speaker at industry events, covering everything from interval funds to alternative investments. She is a CFA charterholder, a member of the CFA Society Chicago, and she holds her Series 7, 63, and 64 licenses. Kim, welcome to the podcast.

Guest 2:

Oh, thanks, jim, I appreciate being on.

Guest 1:

Well, you know, let's start with the big picture. You've argued that private markets are becoming more central to investment conversations today. What's the driver behind that?

Guest 2:

Well, there's really two drivers. So, if you take it from an investor's perspective, a lot of US investors are our portfolios reflect sort of concentration in some of the largest stocks in the US market, and so investors, I think, were taught a lesson in 2022, when neither stocks or bonds performed, and if you think about the classic principles of portfolio diversification, it's to have exposure to a lot of different types of assets that are hopefully moving in different directions when the stock market corrects. So I think we've gotten a taste of 2022 again in the last couple of months of volatile equity market trading and alternative investments. They can deliver on a lot of different goals. So if you have private credit, for example, it can deliver on a retiree's goal for income in retirement.

Guest 2:

If you're talking about private equity, maybe as you're saving for a second home purchase or saving for retirement, you want something with additional upside potential, so private equity is going to bring that. But then, if you think about the firms that manage private equity and private credit, there's a lot of motivation that we see from these money managers who see the individual investor as a huge opportunity. So there's a lot of time and attention being spent on investor education in a way that there wasn't five years ago, and part of that has to do with you know. We don't have pensions anymore, and so the responsibility for saving for retirement is now my own, and so I want opportunities like endowments or pension funds who've long been investing in things like real estate or infrastructure or private equity. These are opportunities with a lot higher return potential. Some of them there's trade-offs, maybe there's additional risk, maybe there's a lack of liquidity, and so that's with private markets. That's why that education is so important.

Guest 1:

Well, there's also been a noticeable trend of companies staying private longer. What do you feel are the drivers behind that shift as well?

Guest 2:

Yeah, well, I mean, we see headlines all the time about private equity buyers of private companies selling those companies after five, six years to other private equity buyers. And the reason we're starting to read more about that is because the IPO markets have been, you know, episodically open and shut, so the capital market windows for these companies haven't been as available or as open. So I think this is much to investment bankers, you know, chagrins. They'd love to see more equity IPOs, but the capital market windows haven't really been conducive to it. But there's also fundamental reasons that companies prefer to stay private.

Guest 2:

So we're seeing a lot of growth happen in the private phase because if you're the entrepreneur, the founder of a business, going public means you're going to have quarterly reporting of earnings. There's going to be a lot more transparency and scrutiny around how you run your business. So I think a lot of business owners are saying you know, we're going to prefer to stay private longer. Private equity is a way for us to get liquidity. Private credit is also a way for us to grow our business. So there's now ways for these business owners to accomplish what they need to grow their business while remaining private, and doing so without that quarterly earnings cadence. That sort of drives short-term decision-making. So I think there's a lot of reasons that compel these companies to stay private for longer, and I don't think anybody's suggesting that that's going to change too soon.

Guest 1:

You know it's funny, I'm an older guy, I remember back in the day, you know, just to even trade equities I was, you know. You looked up your sticker prices in the new stock prices in the newspaper but the barriers to entry were significantly high in terms of just opening up a brokerage account. So, for investors looking to tap into either private equity or private credit, what are the main strategies for an investor to gain access? For an investor to gain access?

Guest 2:

What's different today than it was a few years ago? Five, 10 years ago you needed to be an investor in a private fund. Those private funds throw off K-1s for tax purposes, so that's a pain if you're an individual, even if you're a wealthy individual. They also have suitability restrictions and so if you're not an accredited or a qualified client, you couldn't even get into some of those private funds. So you know, if you know your financial advisor, if you have a lot of wealth, you've probably been approached by private opportunities in real estate or in private equity. But now these private market opportunities are accessible really to everyone, and the reason for that is that they are now available in an SEC registered product wrapper. You know it's a similar, similar, but there's differences. To a mutual fund or an ETF Mutual funds and ETFs are regulated by the SEC. To a mutual fund or an ETF Mutual funds and ETFs are regulated by the SEC. They have independent fund boards that protect shareholders. So there's a type of SEC registered fund that's called an interval fund. There's about 270 interval and tender offer funds that are basically open-ended like a mutual fund, so they're available for purchase.

Guest 2:

And take private credit, for example, you can buy a private credit interval fund. There's about 90 available in the market. You could buy direct lending. There's a lot of interest right now in direct lending because banks have stepped away from lending. You could buy an asset-backed lending fund. Stepped away from lending, you could buy an asset-backed lending fund secured by hard assets. You could buy a structured credit fund. You could buy a multi-strat credit fund. So, partly because the yields on these private credit funds are quite attractive relative to, let's say, high yield or senior loans, you're picking up anywhere from 200 to 400 basis points of additional yield. So there's a lot of individual investor interest. Most of these private credit funds don't have any suitability restrictions and because it's an SEC registered product, it produces a 1099. So for a lot of investors it's an easy way to get private market exposure. For a lot of investors.

Guest 1:

It's an easy way to get private market exposure. Let's talk about education as a component. What is being done from that front? If I'm thinking structured credit funds or things of that nature, there are so many challenges, especially even those who were quibs during the last crisis. What's being done from an education front to really open up these markets more?

Guest 2:

Well, so firms like Apollo, one of the leading institutional alternative managers. They have something called Apollo University. Apollo, for example, is starting with financial advisors, educating the financial advisors, who will then, in turn, educate a lot of investors Like Apollo, blackstone, kkr they all have developed these rich resources and education for investors A lot of it's actually available on their websites. Investors a lot of it's actually available on their websites. So there's much more information because these are effectively, because they're SEC registered products, their retail facing websites have a lot of that education information.

Guest 2:

So if you were a private fund investor, think about trying to find information on a hedge fund or a private equity firm. Their websites basically have a paragraph about the firm and nothing else, or it's restricted access. You can't click into it. So all of these leading alternative managers have had to develop a web presence that they didn't have a few years ago, partly because otherwise, how are they going to serve up some of those educational tools? Because it comes in the form of white papers, videos, other content, as they're trying to educate, not just on the asset class If I'm trying to learn about what is direct lending, but I'm also still trying to understand what is the structure and how do I get liquidity and things of that nature? So there's a lot of education, both on the structure itself, because it may be new to you, but also on the underlying asset class and the benefits or risks of that investment.

Guest 1:

And how are technology and data platforms helping unlock these markets for investors?

Guest 2:

lock these markets for investors Well at the cutting edge. There's going to be a lot of innovation around access to these types of funds. So Hamilton Lane is an alternative manager that was working on a digital share class. So, just as mutual funds have various share classes to offer their products into different distribution channels, a digital share class or a tokenized share class would allow the fund to be basically sold seamlessly without transaction costs. So there's a lot of innovation that I think we're going to see, especially with these private markets funds around tokenization.

Guest 2:

And so we've seen some fintech firms who've uh launched platforms, uh democratized platforms, if you will, to allow anyone uh without a financial advisor, for example, not everybody has a financial advisor, so if you want to buy one, you could go to um, fundrise, yieldstreet, sofi, um, and it's early days in terms of some of that direct to consumer-consumer availability. So, for example, I'm a Fidelity customer with my retirement savings. You can't yet go to Fidelity and just type in the fund's ticker and buy the fund. I think as an industry we will get there, but to support what now? The market now is 270 funds because it's growing very quickly. There were 50 interval funds launched last year. The industry has to play catch up a little bit with respect to the build out of the operations and the technology systems, as you say, to support that level of growth, but I think we'll get there soon enough to make it more open for investors.

Guest 1:

And you know, we've also seen a lot of private equity targeting high growth sectors like cloud, biotech, ai. You know, are there particular sectors or areas that you're personally excited about?

Guest 2:

Before we did this podcast recording, I was speaking with one of there's an interval fund called the Private Shares Fund, and so they're making available basically employee-restricted shares in these private companies that we were talking about, these unicorns that are staying public longer. So there's firms like that that are opening up access to a broad, diversified mix of private companies. I think that's really interesting. That fund has grown and scaled quite dramatically.

Guest 2:

We are seeing one of the trends we reported on in some of the research that we do is that AI now as a theme, investment theme or just in the prospectus disclosures, it's an area of interest for some of these technology funds that are coming to market. So we are seeing some more narrow focused AI funds or technology funds where it's a piece of what they're doing. So I think there's a lot of investors who are, you know, looking at ways to play the AI theme, and the public markets may not be the only way to participate, because a lot of these companies are venture-backed companies and so you need to get in earlier to benefit from the growth in the AI space in the private companies. So we're seeing some interesting venture capital strategies that are just now on file. Takes about 6 to 12 months for these products to launch, but I think we're going to see more of that.

Guest 1:

Just out of curiosity, in terms of thematic investing, are you seeing a spillover in ESG as?

Guest 2:

well, there's one fund that was launched a couple years ago that was focused on impact in a lot of different ways, so it was broadly defined. I would actually say it's almost the opposite right now, just because I think in the US there's been a step back from ESG and so we're starting to see energy funds come back to market. So in the interval fund space there really hadn't been anything dedicated. So now I think some of the energy funds that are coming you know some of them are are energy transition. Some of them are are sort of the old school energy combined with energy transition. So you know it's been a while. You know advisors had sort of I think a lot of investors had over allocated to energy MLP products. So it's interesting to see if energy will make a comeback under the Trump administration. I think that's what some of these new entrants are thinking.

Guest 1:

It's fascinating. So let's talk about risk. Liquidity is often a concern in private markets. Obviously, right now we have a lot of market volatility going on in the midst of trade wars. What should investors keep in mind and how do they look at risk versus traditional products?

Guest 2:

Well, so for anything that's private markets, you need to think about two important differences between, like, a daily liquid mutual fund or an ETF. So a private market strategy let's take private equity or infrastructure. Those are two good examples, because the assets within those portfolios are long duration. You know, a private equity private fund typically would have like a 10-year term. Infrastructure, those investment windows are even longer. It might be like a 15-year term. And so with private market assets, they do bring a lot of potential return and diversification benefits, but the trade-off there is that there's a lack of liquidity, and so sometimes investors talk about the liquidity premium associated with investing in private markets, but that means you don't have the same liquidity and your expectations should be different when you're buying one of these private market strategies than when you're buying an ETF, and I think that there's a high preference for liquidity from daily liquid vehicles. And so I think it's really important, before you would allocate part of your portfolio to private markets, that you think with a longer investment horizon in mind for that segment of your portfolio. And so I think it's in sharp contrast to things like crypto Crypto, people would argue, might be an alternative investment. Even there's gold ETFs for the gold bugs, but those products are fairly liquid. Crypto and gold products are fairly liquid, meaning you could get liquidity within a day or two.

Guest 2:

These semi-liquid products, the interval funds that I'm talking about to these semi-liquid products, the interval funds that I'm talking about, most of them just have a quarterly liquidity window and so, and if everybody, let's say you found yourself in the end of 2008 and everybody wants liquidity at the same time, shareholders would be prorated, so you wouldn't necessarily get the liquidity on the timetable that you're thinking about. So that's really important because, if you think about it, you own your home. If you want to maximize the price of your home when you go to sell it, you're not going to fire, sell it and sell it tomorrow. You're going to hire an agent. You're going to take two or three months, whatever it takes, to get the highest price.

Guest 2:

The same thing would be true for an airport in an infrastructure portfolio or a private company in a private equity portfolio. It takes time to realize that. So the other, besides liquidity, just as I was mentioning, valuation is an important consideration, because valuation is going to work different with some of these long duration assets. There's the risk that the valuation might become stale, and so you want to be thoughtful as you're evaluating private market products. Ask some good questions about valuation frequency, valuation process, make sure you're comfortable with that and make sure you understand when and how you can get liquidity.

Guest 1:

And given the fact that these are long duration assets, I mean, is there any benefit to having an active secondary market develop?

Guest 2:

Yes, I think that this is also an area where, right now, there's one or two firms is also an area where right now, there's one or two firms, one that is bringing liquidity to the secondary market for non-traded REITs. As you know, real estate had been under a lot of pressure in 2022, 2023. There's a firm called Lotus L-O-D-A-S. Lotus is providing secondary market liquidity for non-traded REITs, non-traded BDCs, interval funds, tender funds. The good news for interval and tender funds is that, besides the real estate sector, most of the funds are in a very positive.

Guest 2:

You know there's more demand for the shares of the fund than there is demand for liquidity.

Guest 2:

We monitor that very closely, but there are I think we'll see because they the Lotus Exchange brings buyers and sellers together, and so we need more technology solutions to bring buyers and sellers together, because the market clearing price for a private equity fund in 2008 may look very different than it is in 2025. And so if you're bringing those buyers and sellers together in dislocated markets, you know you can get the clearing price that's supportive of transactions in the market, and so I think that's important with any product, that's if you're providing liquidity on a quarterly basis, but I need the liquidity next week. One of these secondary markets for liquidity would be able to provide liquidity, likely at a discount, but at least they're there as a solution, and I've talked with other firms that are looking at what Lotus is doing and trying to bring buyers and sellers together, effectively arbitraging the difference between where the market price may be and where the NAV of the fund may be. But I think it's still early and there's room for more in terms of innovation in that area.

Guest 1:

Some people have said, like crypto or other areas. It's like oh, this is all brand new and I always sit back and go no, there's always a process. Oh, this is all brand new and I always sit back and go no, there's always a process. And these markets have developed in terms of regulatory regimes and then moving into either OTC, then you get electronification, et cetera, et cetera, and they follow patterns. As it relates to private equity private credit here. As it relates to private equity private credit, here, would you say, reits is the area to watch as the roadmap for the industry I actually do.

Guest 2:

I always say that the interval fund business, which is hot right now, and all these asset managers are looking to launch funds this started 25 years ago. The education started, the product structuring innovation started with non-traded REITs, and so that was what went first, and I think also many investors their first experiences with alternative investments has been with buying a rental property, buying a piece of land, and so these are tangible assets and I think that's why that was an entry, and so what followed the non-traded REITs has been BDCs, and now there's public BDCs, non-traded BDCs, there's private BDCs and business development companies BDCs. Those are a financing tool for US small or middle market companies to get capital to grow. It's unique to us in the US, but that's what followed the evolution of REITs. Now we have interval and tender funds.

Guest 2:

Pretty much anything, any strategy, fits into an interval or a tender fund. So that's why you see hedge fund content, you see private credit, you see infrastructure, you name it. There's endowment style strategies. Interval funds can really house anything. That's private markets, and I think that there's still a lot of growth left, but we're not starting at ground zero. We've been building on some of those innovations.

Guest 1:

And just because you said AI before, I have to ask how do you see AI playing a role in the evolution of private markets, whether it be deal sourcing, portfolio management? Where is AI slipping in here?

Guest 2:

Well, I mean, it's now like the topic of the day, as maybe ESG was three or four years ago. Every industry conference that we attend now, people are talking about how AI is enhancing the client onboarding process if you're a financial advisor, how AI is changing the sales process if you're a sales manager at a large asset management firm. Ai is changing how we build products, how we structure products. It's going to touch every aspect, every aspect, even if the investor is not aware that it's happening. I think the SEC with Chairman Atkins he's a big proponent of AI and crypto, and so I think we're going to see the SEC be supportive in a way. Now I think that the SEC is going to want to make sure that asset managers are disclosing the nature of the use of AI.

Guest 2:

A lot of companies, asset managers who are worried about giving away their secret sauce. They have closed door chat GPT tools, so it's something that their portfolio managers and analysts can be comfortable using and making sure that their data doesn't drift out, you know, isn't educating the AI tools outside of their firm. So we're seeing rapid innovation and there's going to be consequences. There's going to be upsides and downsides and I think, as an industry, we kind of have to. We're in testing mode with some of this stuff.

Guest 2:

But I do think that, like you know, it was just like I was speaking with my dad last night. He said somebody at his church recommended he read a book and instead of reading the book he did a chat, gpt summary, to see if he actually wanted to spend the time reading the book. That's going to be true for investment products too. Right, you're going to drop in a fund. You're gonna be like well, tell me, summarize. You know the benefits and the risks of this fund, and so you know, right now you read a fact sheet, maybe you read a prospectus, but I think that there's going to be a lot of tools that help us make decisions, um, and hopefully in a more thoughtful way.

Guest 1:

I'll give you one fun little hack. With with chat GPT that I used. The other day, I got a piece of mail and I was like this looks real but I'm not sure. So I took a picture of it and had it, analyzed it and it was like this is fake. Here's why. And when it did all this research, I was like I was. I was worried for nothing.

Guest 2:

You know we're all in it every day. Every one of us gets a scam request. If it's those stupid toll road violation texts, you get one a week and you think, oh gosh, some of this must be. It's getting harder to tell what's a scam and what's legit. So yeah, I mean, I think it's like anything.

Guest 2:

But you know, if you can be an investor in some of that cutting edge technology, you know there's going to be a lot of losers in the venture space and AI.

Guest 2:

But that's why, when you're investing in venture capital, you know you want to invest with one of the best, most skilled venture capital managers. But they're also basically placing a lot of different bets right, because not every investment is going to be a winner. Basically placing a lot of different bets right, because not every investment is going to be a winner. So I you know we always say that manager skill in private markets is even more important than with a mutual fund manager selection, because the return dispersion, you know, between the best and the worst mutual fund manager is actually pretty. It's a pretty tight range, whereas with private markets the best and the worst there's a huge, like you know, 10% return difference between the best and the worst in private markets. So manager selection is all the more important when you're talking about hedge funds and private markets, and so you know. That's why. That's why that's important that you're investing with a manager that is time tested, has a track record, and you can be comfortable that they know what they're doing.

Guest 1:

Well, kim, unfortunately we've made it to the final question of the podcast. We call it the trend drop. It's like a desert island question. So if you could only watch or track one trend in private markets, what would it be?

Guest 2:

Okay, I'm a big fan of real asset strategies and we've seen a lot of movement because we're all facing higher prices at the grocery store and whatnot. So inflation is going to continue to be top of mind because we're just at elevated prices and even if the inflation rates come down, we're still going to be suffering from higher prices. So things like farmland investing, things like infrastructure investing, which can give you yield, but also inflation protection, I think we're going to see a lot of demand for those real asset strategies around the globe, strategies around the globe and that's an area where we've seen some new products get launched, especially in the infrastructure category in the last year. But I think we're going to see more in the way of other inflationary protected real asset strategies, because I think that's a gap in most investors' portfolios.

Guest 1:

Well, kim, thank you so much for your time today, Incredibly informative, and it's a whole new world, so thank you.

Guest 2:

Thanks, Jim.

James:

Thanks so much for listening to today's episode and if you're enjoying Trading Tomorrow, navigating capital markets, be sure to like, subscribe and share, and we'll see you next time.