Investors seeking to protect their principal should understand how certain investment structures handle sudden market declines. During a market downturn, many investors panic, selling assets regardless of price. A sudden dip in the market can quickly spiral into a “run on the bank” as investors sell indiscriminately to get out of the market. This market dynamic is a very real risk, even for level-headed bond and loan investors.
Let’s consider what may happen to daily-traded credit funds during a period of market dislocation. These vehicles may face redemption requests that require them to sell their bonds and loans at significant discounts, which locks in a loss and may destroy investors’ principal.
Interval funds, on the other hand, offer periodic liquidity, often through quarterly redemptions. This structure is designed to avoid forced selling into a panic. Similarly, interval funds do not have to hold a large cash buffer to guard against redemptions and therefore can operate fully invested. More importantly, periodic liquidity enables interval funds to invest throughout the credit cycle and during challenging market conditions.
Having the flexibility to invest through the ups and downs of the credit markets provides interval funds with the opportunity to acquire assets at “fire-sale prices” during market panics, potentially increasing returns. So, while daily-traded credit funds may be forced sellers when markets dip, interval funds look to be opportunistic buyers.
This structural advantage may help investors protect their principal and generate potential higher returns.