Opening the door to private markets using the “closed” fund structure

Jul 23, 2021
  • BlackRock

Closed-end funds can offer access to high growth private markets in an investor friendly structure

While the size of the listed closed-end fund (“CEF”) universe pales in comparison to open-end mutual funds (“mutual funds”) or exchange traded funds (“ETFs”), CEFs offer investors several potential benefits that are often overlooked. Unlike mutual funds and ETFs, the “closed” structure allows for greater flexibility in the types of investment strategies that can be used and helps portfolio managers stay invested for the long term without forced selling. Additionally, managing daily investor flows may constrain a portfolio manager and impact a fund’s return in two ways: 1) they may be forced to hold short-term cash investments which may be a drag on returns and 2) they have less flexibility to invest in less liquid securities, including private investments, which may limit potential upside. CEFs are free from the constraints of investor influenced daily liquidity, potentially increasing income and returns.

The rise of private markets

There’s been a shift of wealth creation toward private markets, however, private investments are typically difficult to access. We believe private equity exposure is important as it gives investors access to the full opportunity set. For example, over the last 20 years, the number of private companies has increased 41% while the number of public companies have decreased by about 36%. 

Exhibit 1: Rise of private markets

Rise of private markets

Source: U.S Census Bureau – Statistics of U.S Businesses; Droidge, Karolyi and Stulz (1988-2017) . Represents the latest data available as of February 5, 2021.

The shrinking of public markets may also come at a cost to the ordinary investor. As companies seek to go public through an initial public offering (“IPO”) at increasingly rich valuations, there may be “less juice left in the squeeze” or additional upside for the public markets. Combining public and private markets in your portfolio may enhance income and returns. 

Exhibit 2: Companies are staying private for longer

Companies are staying private for longer

Source - National Venture Capital Association. Data as of December 31, 2019. Middle display: Source: Journal of Applied Corporate Finance. Private Equity and Public Companies. “The Growing Blessing of Unicorns: The Changing Nature of the Market for Privately Funded Companies.” Comparative Summary Statistics for the Unicorn Sample: 2015 vs. 2020. See important information section for methodology on how sample was determined. Unicorns are start-ups valued at $1Bn or more. Right display: Source – Stripe; “Stripe has raised a new round of funding to accelerate momentum in Europe and reinforce enterprise leadership”. Stripe data as of 3/14/21. Amazon source: “TechCrunch, A look back in IPO: Amazon’s 1997 move.”

Harvesting the illiquidity premium

The concept of “harvesting the illiquidity premium” is rooted in the ability of a CEF to hold securities that don’t offer daily liquidity such as private investments. Holders of less liquid securities are generally compensated for this additional risk with an illiquidity premium, which can help boost returns relative to a fund that invests solely in liquid public markets. We believe CEFs are the ideal vehicle to hold these investments given the absence of daily investor flows, unlike mutual funds and ETFs. 

Easy to implement

 Historically, private markets were exclusive to institutions and high net worth individuals that met certain requirements and investment minimums. BlackRock is seeking to increase access to private markets by providing exposure to all investors via CEFs. Listed on a national stock exchange similar to ETFs, CEFs can offer access to private markets with the benefits of intra-day liquidity, no investment minimums and 1099 tax reporting.

Exhibit 3: Benefits of the CEF Structure

Benefits of the CEF Structure

Source: BlackRock

While not all CEFs invest in private companies, the BlackRock CEFs listed in Exhibit 4 can invest up to 25% of their portfolio in private investments. This is a unique way of taking advantage of the CEF structure and potentially enhancing returns.

Exhibit 4: Expanding the investment universe

These BlackRock CEF’s can invest up to 25% of their portfolio in private investments

Ticker

Fund

Category

Premium/Discount

Distribution Rate

BST

Science and Technology Trust

Technology

-0.2%

4.8%

BSTZ

Science and Technology Trust II

Technology

-1.9%

4.9%

BMEZ

Health Sciences Trust II

Healthcare

-2.8%

5.9%

BCAT

Capital Allocation Trust

Multi-Asset

2.9%

5.6%

BIGZ

Innovation and Growth Trust

Small Cap Growth

4.6%

5.9%

Source: BlackRock as of 7/7/2021. For performance information please click the fund links above. Distribution rate is calculated by taking the fund’s latest declared distribution, annualizing it, and dividing it by market close on 7/7/2021. Fiscal year to date (through 6/30/21) distribution return of capital estimates are as follows: BST: 0%, BSTZ: 0%, BMEZ: 0%, BCAT: 53%, BIGZ: 100%. For more information please see the closed-end fund section 19 page.

 Click here for a full list of BlackRock Closed-End Funds

The Growing Blessing of Unicorns: The Changing Nature of the Market for Privately Funded Companies. Keith C. Brown and Kenneth W. Wiles, University of Texas at Austin. Sample set was determined as follows: The demographic and financial characteristics for sets of active unicorns at two different points in time: August 31, 2015 (the sample from our original study) and March 1, 2020. As before, to be included in either sample, a company must satisfy the following conditions: (1) have always been private; (2) have received at least one funding round of institutional capital; (3) not be a divisional buyout of a public company; and (4) have an estimated market valuation of $1 billion or more. Throughout the entirety of the surveying process, the identity of and data for these samples were gathered from several sources, including CB Insights, Capital IQ, CrunchBase, PitchBook, Preqin, and Wells Fargo, as well as their own research.