What risks and considerations should firms address when expanding semi-liquid fund offerings?
Without careful planning, rapid expansion can dilute brand equity, expose liquidity vulnerabilities during periods of elevated redemptions, and undermine trust through inconsistent valuations. Operational strain from outdated technology and a weak deal pipeline can further impair execution and long-term performance. Here are some of the risks, considerations, and mitigation strategies for firms planning to expand into semi-liquid funds.
Investor awareness and trust: A survey of retail investors indicates that limited awareness and trust are significant challenges to investing in alternative assets.23 Investment firms have an opportunity to establish a robust brand presence within the semi-liquid fund segment, as these innovative structures appear to be gaining traction. Leveraging an established and trusted brand to enter this new market can be an effective strategy. About 47% of survey respondents indicated that financial backing from large firms will positively influence trust.24 Furthermore, investor education initiatives can contribute to cultivating trust, raising investor awareness, and increasing brand recognition. Investment advisors often play a crucial role in assisting firms to comprehend customer requirements and develop superior products. Collaborations with investment advisors can be essential for elevating brand awareness and driving sales growth.
Liquidity management: Semi-liquid funds can face asset–liability mismatches due to short- to medium-term redemption windows and medium- to long-term assets. It’s important to handle liquidity events systematically to help avoid liquidity issues. This can be done by controlling redemptions and managing liquidity. To keep things balanced, managers often use a combination of tools. For example, they might control redemptions by adding notice periods, setting redemption limits, or applying early withdrawal penalties. Some funds use lockups or gates to slow outflows, or stagger payouts so that investors receive returns gradually as the underlying assets produce cash. On the flip side, managing the fund’s liquidity proactively can be just as important. This could mean holding back a portion of capital in liquid reserves, using new investor inflows to meet redemptions, or making sure the types of assets in the portfolio match the fund’s redemption schedule. Some funds also establish credit lines or invest across different vintages to create more flexibility. Liquidity management is often about building enough resilience into the structure so that investors can access their capital without putting the fund under unnecessary pressure.
Frequent valuations: Unlike drawdown funds, which typically perform portfolio valuations every quarter when the financial statements are available, many semi-liquid funds offer more frequent subscriptions and redemptions. Consequently, these funds will likely have to perform valuations more often, as net asset value is the basis for these transactions. Valuation considerations can hold even greater importance for traditional investment firms since expertise in the valuation of private assets often does not exist within these firms. According to the 2024 Deloitte Fair Valuation Pricing Survey, about 63% of firms use external experts in some capacity to value private equity assets, and 52% do so for private credit assets.25 Alternative data can help firms arrive at holistic valuations even when quarterly financials are not available. Investment firms can also use AI to accelerate the portfolio valuation process. The firm’s revenue is also tied to the net asset value, and hence, the independence of the valuation process can help enhance investor trust. External third-party valuations or assurance services may be useful tools to address this conflict of interest. Furthermore, different firms holding the same portfolio company can value the company quite differently due to limited regulation.26 As such, being conservative and maintaining audit trails will likely be important.
Management of rising administrative complexity: Engaging with retail investors can necessitate additional operational overhead, especially for alternative investment management firms. Retail investors typically expect frequent communication, thorough disclosures, seamless transactions, data privacy, and various support services. Firms may have to reevaluate their custodian arrangements, transfer agency relationships, and risk management frameworks. Firms may use blocker corporations in semi-liquid fund structures to help manage tax obligations and streamline compliance across diverse investor types, enabling more scalable and transparent operations. Alternative investment firms will likely have to develop a comprehensive strategy to manage the increased administrative costs associated with accommodating a larger number of investors with smaller investment sizes.
Efficient investment sourcing: Semi-liquid funds accept subscriptions at periodic intervals. To help deploy incoming capital promptly and avoid cash drag, it’s important to manage sourcing effectively and maintain an optimal deal pipeline. This will also likely help ensure the fund remains aligned with the stated fund strategy in a cost-effective manner. Strategies such as investing in limited partner-led secondaries involve putting capital into multiple companies, which can lead to over-diversification and hinder the fund’s focus on its investment objective. By contrast, direct investments, coinvestments, and general partner-led secondaries may allow firms to achieve concentrated exposure and maintain alignment with their fund objectives. These investment options are typically less costly compared to investing in private capital funds, which can add another layer of fees. Additionally, strategic alliances with other financial institutions can support firms in sustaining steady and diversified deal flows.27
