Interval Funds and the Illiquidity Premium: Strategic Diversification and Alternative Asset Access for Income-Focused Investors

In an era of historically low yields and volatile traditional markets, income-focused investors are increasingly turning to alternative strategies to enhance returns and diversify risk. Among these, interval funds have emerged as a compelling vehicle, offering a unique blend of liquidity, access to illiquid assets, and the potential to capture an illiquidity premium. This article examines the role of interval funds in strategic diversification, their performance relative to traditional bonds, and the implications of the illiquidity premium for income-focused portfolios.

The Rise of Interval Funds: Bridging Liquidity and Alternative Assets

Interval funds, which allow periodic redemptions (typically quarterly) while maintaining exposure to illiquid assets, have experienced explosive growth. By 2024, assets under management (AUM) in these semi-liquid vehicles , . This growth is driven by retail investors seeking access to alternative assets such as private credit, which offer higher yields than traditional fixed-income instruments according to market analysis.

The structure of interval funds enables investors to participate in private markets-such as private equity, debt, and real assets-without sacrificing complete liquidity. Quarterly redemptions, usually ranging between 5% and 25% of net assets, provide a buffer for liquidity needs while allowing managers to maintain long-term holdings in illiquid investments. This hybrid model is particularly appealing in a market where traditional bonds struggle to deliver meaningful income, and public equity markets face elevated volatility.

The Illiquidity Premium: A Compensating Return for Liquidity Constraints

The illiquidity premium, a well-documented phenomenon, refers to the additional return investors demand for holding assets that cannot be quickly converted to cash. For income-focused investors, this premium is critical in environments where traditional assets underperform. According to Amundi's 2025 capital market assumptions, real and alternative assets-including private equity and infrastructure-are positioned to deliver double-digit returns and significant diversification benefits.

The appeal of the illiquidity premium is amplified by the breakdown of traditional diversification mechanisms. For instance, stock-bond correlations have weakened in recent years, undermining the effectiveness of conventional asset allocation strategies. In this context, interval funds offer a structured way to access illiquid assets while mitigating liquidity risk through periodic redemptions. This approach allows investors to align their time horizons with the maturity of the underlying assets, thereby optimizing the trade-off between yield and liquidity.

Performance and Diversification: Interval Funds vs. Traditional Bonds

Empirical evidence underscores the advantages of income-focused interval funds over traditional bonds. A 2025 study titled found that interval funds outperformed both passive and active ETFs, . This outperformance was particularly pronounced in nontraditional bonds, where the illiquidity premium translated into higher risk-adjusted returns according to performance analysis.

Case studies further illustrate this dynamic. For example, over five years, compared to 1.5% for the IA Sterling Corporate Bond sector. Such performance highlights the potential of interval funds to serve as a core income-generating component in diversified portfolios. However, according to performance benchmarks.

Challenges and Strategic Considerations

While interval funds offer compelling advantages, they are not without risks. The illiquidity premium requires investors to accept the possibility of delayed access to capital, particularly in private markets where exit activity has slowed. Additionally, managers must implement robust liquidity strategies to balance redemption outflows with inflows, a challenge exacerbated by the removal of the 15% private credit cap in interval funds according to industry analysis.

For income-focused investors, strategic allocation to interval funds should be guided by three principles:
1. Time Horizon Alignment: Investors must ensure their liquidity needs align with the redemption schedules and maturity profiles of the underlying assets according to market research.
2. : Combining interval funds with other liquid alternatives-such as BDCs or liquid private credit ETFs-can enhance risk-adjusted returns according to alternative investment analysis.
3. Fee Transparency: While higher fees are often justified by the illiquidity premium, investors should scrutinize expense ratios and performance benchmarks according to performance studies.

Conclusion

Interval funds represent a strategic bridge between liquidity and alternative assets, offering income-focused investors access to the illiquidity premium while mitigating the risks of complete illiquidity. As traditional markets struggle to deliver meaningful yields, these vehicles provide a compelling solution for diversification and income generation. However, their success hinges on disciplined liquidity management, fee transparency, and a clear understanding of the trade-offs between yield and accessibility. For investors willing to navigate these complexities, interval funds may well become a cornerstone of a modern, diversified income portfolio.