In recent days, investors have been inundated with headlines about unlisted funds hitting redemption limits and gates closing on client outflows, most notably in the Starwood Real Estate Investment Trust (SREIT) and the Blackstone Real Estate Investment Trust (BREIT). While this has made front page news at all major financial journals recently, these structural issues and limitations are anything but new.
Often pitched as semi-liquid solutions for wealthy individuals to invest in private markets, the true liquidity and transparency of such funds have long been oversold. This may leave investors and their wealth advisors in compromising positions, while also creating opportunities for allocators well-versed in the secondary market to pick up shares at a discount.
With that in mind, it’s important to know how an investment like this will fit in the client’s current portfolio makeup and how it lines up with their ultimate goals, preferences and needs. History has told us that the best—and possibly first—question a wealth advisor can ask is: “Is this the best structure for my client?”
But before we examine other avenues, let’s first look at why we are here…
Closed-end funds have pre-set withdrawal redemption limits. Investors may request a withdrawal for any reason—be it a sudden need for liquidity or a downturn in the fund’s performance. When there is a surge on withdrawal requests exceeding that threshold, limits must be enforced.
The chart below illustrates this concept as it relates to historic redemption requests as a percentage of allowable liquidity limits. As fund sponsors close the gates, a common emotional reaction from investors is a panic-driven “run on the bank.” When this happens, the fund receives an exponential rise of redemption requests, which may cause an abrupt sale of holdings, followed closely by a cycle of pressured returns and further increasing redemptions.
The key is fund managers have the ultimate control of liquidity. And in a declining market, the valuation of the fund decreases along with flows into it. In situations when a fund that previously provided liquidity in any given quarter is suddenly cutting back the requested redemption amount to investors, wealth advisors can feel rightfully burned.
The best possible client experience must remain one of the foremost goals of any wealth advisor’s strategy. To create that, it is necessary to have an auxiliary path to alternative investing where the advisor has additional control of liquidity.
As a former member of the portfolio management team at a registered fund-of-funds, I have first-hand experience with this. There are logistical challenges that come with managing liquidity in a structure offering quarterly redemptions while having a significant allocation to private investments.
These structures work well when times are good and new assets are coming in. But when the flows stop, redemption pressures can exacerbate, and managers are often forced to restrict liquidity. However, once a fund manager goes down that path, investors often begin to panic and rush into the queue for redemptions, only adding more pressure to the fund.