The Investment Company Act of 1940: 77 Years Later

On this day in 1940, President Roosevelt signed the Investment Company Act of 1940.  Previously, both houses of congress had approved the ’40 Act unanimously. The ’40 Act, is the primary source of regulations for the multi-trillion dollar investment industry. The ’40 act defined and regulated investment companies, and provides investors with protections against conflicts of interest, misappropriation of funds, excessive fees, and undisclosed risks.

As he signed the bill, President Roosevelt declared:

We have come a long way since the bleak days of 1929…. I have great hopes that the act which I have signed today will enable the investment trust industry to fulfill its basic purpose as a vehicle to diversify the small investors risk.

What is a ’40 Act Fund?

The investment companies that the 1940 Act protections apply to are known as 1940 Act Funds, or ’40 Act Funds Broadly speaking, there are three types of  ’40 Act Funds: Closed End Funds, Open End Funds, and Unit Investment Trusts. Open end funds and closed end funds are the most common type of

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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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Non-Traded REIT and BDC Sponsors Launching Interval Funds

Non-traded REIT and BDC sponsors are entering the interval fund space en masse. This was a key trend in 2016 and it is continuing in 2017. Here is a partial list of Non-traded REIT and BDC Sponsors with interval funds in various stages of launch.

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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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