A semi-liquid fund is only as strong as its operating model

Ankit Jain, Group Head of Private Markets, Carne

As the semi-liquid market becomes more established, investors are looking beyond investment strategy and paying greater attention to how funds operate.

That’s borne out in how the wider industry perceives fund management. One indication of this trend is the increasing attention being given to liquidity management, valuation and governance when assessing semi-liquid funds. Morningstar’s ratings framework, for example, assigns significant weight to these areas within its ‘Process’ pillar.

As semi-liquids grow in popularity, attracting a wider investor base, operating quality is inevitably becoming a test of how a fund is perceived overall.

The investment proposition depends on process

Semi-liquid funds operate differently from daily-dealing UCITS funds and traditional closed-ended private market structures. They bring together long-term investment strategies with periodic subscriptions and redemptions, often investing in assets where valuations depend on judgement rather than continuous market pricing.

They give investors regular opportunities to enter and exit while holding assets that may take time to sell. Balancing those two characteristics requires more than the terms established when a fund launches. Managers need processes that allow them to monitor liquidity, oversee valuations, identify potential pressure points and adjust as conditions change.

The resulting diversity of approaches is evident in our analysis of 200 European semi-liquid private market funds, which found considerable differences in liquidity management, redemption arrangements and governance across the market. No single operating model has emerged as the standard, which means the way semi-liquids are designed and managed has become an important point of differentiation.

Semi-liquid funds were first seen as a way to broaden access to private markets. Investors are now considering how these structures will function in different market conditions and as they develop over time, which explains why liquidity management, valuation governance and oversight are becoming more prominent in assessing funds.

The link between process and performance

Of course, process can’t account for performance alone. Good governance cannot make up for poor investment decisions, just as a well-designed operating model cannot, on its own, deliver strong performance. Morningstar’s decision to weight process so heavily does, however, underline how closely the two are connected in a semi-liquid structure.

The way liquidity is managed can dictate how much of a portfolio can be committed to longer-term assets and how a fund responds when investors seek to redeem. Valuation methodologies shape the prices at which investors enter and exit the fund. Governance provides the mechanisms for identifying emerging risks, challenging decisions and escalating issues when necessary. Weakness in any of these areas can have consequences for both existing investors and those looking to invest.

There is also an important difference between having policies in place and showing that they work as intended. Most funds have documented approaches to liquidity, valuation and governance. The more important question is whether those arrangements continue to hold up as assets grow, portfolios develop, distribution broadens and market conditions change.

This makes operating quality about more than following an established process. It requires the judgement to recognise when the assumptions behind that process may no longer apply, and the ability to adapt as the fund evolves.

Europe adds another dimension

Under AIFMD, areas including risk management, valuation oversight and liquidity monitoring sit within the wider governance framework around a fund. The processes attracting greater attention in assessments of semi-liquid funds go beyond portfolio management. They also depend on how effectively the wider governance and oversight model operates.

This does not change the central role of investment expertise – or mean that strong governance can make up for weak investment decisions. Instead, it reflects the way investment management, liquidity oversight, valuation governance and risk management interact within European semi-liquid structures.
The investment manager remains responsible for investment decisions and portfolio performance, while the AIFM, board and other service providers form part of the wider governance and oversight structure. Its effectiveness depends not only on where responsibilities sit, but on how well those involved share information, provide challenge and make decisions when issues arise.

What good operating models have in common

While each semi-liquid fund will have its own characteristics, there are four shared hallmarks of resilient operating models:

Liquidity should reflect the portfolio

Dealing frequency, notice periods, redemption limits and other liquidity tools should be aligned with the assets in the portfolio, rather than driven solely by distribution ambitions. Those arrangements also need to be revisited as the portfolio develops, the fund grows and its investor base changes.

Valuation requires ongoing oversight

Private market valuations often involve judgement. Alongside appropriate methodologies and technical expertise, this requires consistency, documentation, independent challenge and clear escalation where issues arise. Valuation is therefore an ongoing governance responsibility, not simply a calculation carried out at set intervals.

Governance needs to develop with the fund

An approach that works when a fund launches may not be sufficient as it becomes larger, more complex or more widely distributed. Reporting, oversight and escalation arrangements need to evolve with the fund rather than remaining tied to decisions made at the beginning.

Transparency helps set expectations

Investors need a clear understanding of both the liquidity a fund aims to offer and its limitations. Explaining how redemptions work, how valuations are determined and when liquidity tools may be used helps set realistic expectations from the outset.

Fund quality is about more than investment strategy

Morningstar’s methodology is not a new standard for semi-liquid funds, but it is a useful indication of how the market is assessing them as the sector matures.

Investment expertise remains central to fund management. But investors are looking at more than the assets a fund holds and the strategy behind them. They are also considering whether the fund has the processes, governance and oversight needed to operate effectively as it grows and conditions change.

For semi-liquid funds, that makes operating quality part of the broader assessment of fund quality – not simply a matter of infrastructure behind the investment strategy.

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