Semi-liquid funds: managing the structural liquidity mismatch

Open-ended private markets funds – across private credit, real estate, infrastructure and certain private equity strategies – offer investors periodic liquidity against portfolios of inherently illiquid assets. These terms of engagement are clearly spelt out in a vehicle’s offering documents at the time of investment – a point lost in much of the current coverage of the topic of redemptions.

Redemption terms are central to managing what is a structural liquidity mismatch inherent within semi-liquid funds: assets are originated, held and realised over multi-year horizons, while investors may have the ability to redeem monthly or quarterly.

In benign conditions, the process works smoothly, supported by income, natural repayments and modest cash buffers. Under stress, however, the timing gap between asset liquidity and investor demand becomes more pronounced, including when fear of being the 'last to the exit' as a result of self-fulfilling headlines, perhaps, sees sentiment override the fundamentals.

Liquidity management tools and mechanisms

To cope with the less benign periods, managers employ a range of liquidity risk management tools, which are an integral part of fund design rather than emergency measures. Redemption gates are the most visible: they cap the proportion of the fund that can be redeemed at each dealing date, typically allocating available liquidity on a pro rata basis and deferring requests that exceed the cap.

Notice periods and lock-ups further align investor expectations with the underlying asset profile. Redemption fees or anti-dilution adjustments may be applied with the aim of ensuring that transaction costs associated with meeting withdrawals are borne by redeeming, rather than remaining, investors.

In more dislocated markets, managers may also suspend dealing where asset valuations cannot be determined with sufficient confidence, or potentially establish side pockets to isolate particularly illiquid exposures. Alongside these measures, many funds maintain credit facilities – either at the subscription or asset level – which can be drawn to meet short-term liquidity needs.

Used judiciously, such facilities can allow managers to avoid selling assets at unattractive prices and to bridge temporary imbalances between inflows and outflows.

In more acute scenarios, managers may implement extraordinary liquidity measures, typically following sustained redemption pressure (for example, where gates have been applied over multiple dealing periods). This can involve suspending dealing and organising a structured secondary process, allowing investors to sell interests to existing investors or third parties.

Such processes may take time to execute and transactions are typically completed at a discount to the last published NAV, reflecting prevailing market conditions. Where structured as a pro rata or 'vertical slice' of the portfolio, this can support orderly price discovery while seeking to treat investors equitably and avoid forced asset sales. The trade-off remains that exiting investors may experience delays and crystallise a discount, while remaining investors retain exposure to the portfolio, albeit with potentially reduced scale and flexibility.

Investor considerations and key risks

Given the range and discretion of these liquidity management tools, it is important that investors undertake thorough operational due diligence prior to committing capital. This should include a detailed review of a vehicle's constitutional and offering documents to ensure there is clear and explicit disclosure of the terms governing redemptions, including any gates, suspensions, secondary processes and fees.

Investors should also understand the circumstances under which these tools may be deployed, and the degree of discretion afforded to the manager in periods of market stress. In practice, the effectiveness and fairness of liquidity management is heavily dependent on how well these mechanisms are defined ex ante and communicated to investors.

For investors, the key consideration is that these tools primarily manage the timing of liquidity, rather than eliminate its underlying constraints. Gates and notice periods mean that access to capital may be delayed, particularly during periods when liquidity is most in demand. Redemption adjustments can reduce the realised value of an investment at exit. Suspensions, while typically temporal, represent a full pause in liquidity.

The use of credit facilities warrants particular attention. While they can smooth redemption flows, they also introduce incremental leverage into the fund. This can enhance flexibility in the short term but increases the exposure of remaining investors to future market movements and financing costs. In effect, borrowing to fund redemptions may shift some of the economic burden – through interest expense or future asset sales – onto those who remain invested. The appropriateness of this approach depends on the scale and duration of its use, as well as the resilience of the underlying portfolio.

Ultimately, liquidity in these structures should be viewed as conditional and state-dependent. It may be argued that investors are compensated for bearing illiquidity through enhanced return potential, however any such premium is realised over time and may be accompanied by constraints on access to capital. A clear understanding of fund terms, portfolio characteristics and the manager's approach to liquidity management is therefore essential.

A balanced perspective is important: these mechanisms are designed to protect the collective interests of investors and to preserve long-term value. However, they also require investors to align their own liquidity needs with the realities of the underlying assets.

Questions for asset managers

• How does the fund's dealing frequency align with the expected realisation profile of the underlying assets?
• Under what conditions would redemption gates, suspensions or side pockets be used, and how have these operated historically?
• To what extent can credit facilities be used to meet redemptions, and what limits or safeguards are in place?
• How is the cost of providing liquidity (e.g. transaction costs, financing costs) allocated between redeeming and remaining investors?
• What stress testing is performed on the fund's liquidity under adverse market scenarios?
• How transparent is the secondary market for the fund's assets, and what level of discount might be expected in a forced sale scenario?