Pathway Energy Infrastructure Converts to Interval Fund

On July 26, 2017, Pathway Energy Infrastructure’s board of directors approved the Company’s plan to convert to an interval fund. The change of this fundamental policy will be submitted to shareholders for a vote in a forthcoming proxy. The Company is also making adjustements to its investment strategy to focus on broader infrastructure opportunities. The new Company name will be “Pathway Capital Opportunity Fund.” Shareholders will need to vote on the change in an investment strategy as well. Details on the new structure and strategy are included in a draft registration statement

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The Interval Fund Rule: Charting New Territory

Interval funds may seem like a new concept, but they were originally created as a result of a SEC recommendations in its landmark 1992 study : “Protecting Investors: A Half Century of Investment Company Regulation.”  This study concluded that the rigid delineation between “open end” funds, providing daily liquidity, and “closed end funds” , which do not offer daily liquidity, limited the ability of sponsors to offer innovative investment products to investors:

The Division has  concluded it would be appropriate to provide the opportunity for investment  companies to chart new territory between the two extremes of the open-end and  closed-end forms, consistent with investor protection. >

As a result of this recommendation, the Rule 23c-3 under the 1940 Act, known as interval fund rule was adopted in 1993.   Under the interval fund rule, closed end interval funds are required to offer to repurchase between 5% and 25% of shares at NAV at predetermined intervals(quarterly, semi-annually, or annually). The Fund is required to provide advanced notice to shareholders between 21 and 42 days in advance of repurchase offer .  Interval Funds also file N-23c-3 with the SEC within 3 days of sending shareholder notification of a tender offer. 

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Visualizing The Secular Shift in Retail Alternative Investments

As non-traded REITs and BDCs have shrunk, registrations of new interval funds have grown rapidly. Launches of interval funds have overtaken non-traded REITS and BDCs  (Source: SEC Filings)

The market for retail alternative investments is in the midst of a dramatic secular shift.   High commission  non-traded REITs and BDCs were a core revenue source for many smaller broker-dealers.  However  sales have collapsed.     Lightstone recently laid off most of its sales staff and closed its non-traded REITs. Lightstone will likely be launching Reg D and Reg A+ offerings. Inland has struggled to raise capital for its REIT although it continues to dominate the 1031 Exchange space, and is in the process of launching a private closed end fund.  FS Investments and Griffin Capital have both diversified their product suites away from traditional retail alternative investments, into newer product structures designed to achieve the similar objectives.

Non-traded REITs and  BDCs peaked right before the  ARCP accounting scandal which ultimately led to the collapse of the Nick Schorsch empire.  This led to many broker-dealers suspending sales from anything affiliated with then largest non-traded product Sponsor. Finra 15-02, which increased the transparency on client statements, made it harder for advisors to get away with charging the traditional 10% sales load.  The looming fiduciary standard, which required broker-dealers to act in the best interest of clients, also led many broker-dealers to suspend or slow down the sales of high commission products.

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Comparing BDCs and Interval Funds

With Financial Times coverage of closed end interval funds, and the recent growth in credit focused closed end funds, its a good time to compare the business development company structure to the closed end fund structure(including interval funds). Both provide investors with protections under the 1940 Act, and BDCs are also technically a type of closed end fund, but BDCs have several key differences in terms of fees, regulatory and filing requirements, and investment restrictions. These differences are important for investors, asset managers, and those involved in fund distribution.

Here are interactive tables comparing BDCs and Closed End Interval Fund:

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