Note Funds with Upside

[Paul C.]

Does anyone know of any note funds where investors participate in the upside?

I've seen funds that offer a preferred 8% or 10% return, but that's it.  I'm interested in seeing if there are funds with possibly a lower (or even no) preferred return, but with meaningful participation in the fund's total return.

If you're not comfortable naming a fund on a forum, please feel free to PM me.

Thanks in advance.

[Dion DePaoli]

The most popular structure I have seen is 10/50 lately outside of no split.  I think there is investor lure to be able to purchase or own notes or the underlying collateral in some of these fund.  So they attract a group of folks to some degree.  These funds raise a couple bucks but nothing major an issue onto itself.  

Investors need take care, the operators and promoters may not be all that experienced.  It is one thing to say I was investing in notes and another thing to run a Reg D fund.  One idea is being in the business investing in notes, the other is being in the investment fund business.  I think some of the managers have romantic ideas of what it means to own a fund and find out you need some serious AUM and fees to keep the lights on.   

I think in general note funds with prefs at 10% should be approached with large amounts of caution.  I have ran at 10% and a little below it and currently have some closed end group investments in that ballpark. The pref is frankly too high and so there is a higher level of risk that innately comes into the fund so the manager can hit the pref.  Playing catch up to that pref can be tiring at best.

I have not seen, heard or discussed a typical 2/20 in this space in quite some time.  I ran one a couple years ago but it was for higher net worth investors more institutional in nature.  The natural person investors seem to get attracted to the pref.  Over some brief time and competition the pref plus split have moved to the general place they are now.  I would imagine that the general issue here is what everyone really believes can be made from investing in loans.  

Remember, if I pref 10 and want a management fee of 2, I have a 12 bogie out of the gate. A $10M raise gets the manager $200k.  That is pretty tight to operate.  I could argue, you are really not operating well and paying yourself unless the fund is with a larger company.  Then we take the split from where?  If I had to invest to get you over 12 to pay pref and management, just how much additional net do we all think we are going to find?  Now, add in liquidity issues.  The higher the idea of that funds total return, the more they will need to turn to non-performing.  The more NPL's they turn to, the higher the chance the advances cap the rise of the total return.  Welcome to the scale of economies.

To be an investor in a Reg D fund you need fall under the exemption for accredited investors.  So yes, accredited investors only.   

Note funds really should look more like bond funds and less like equities funds.  Funds which need to rely on high total return marks are not going to be successful funds.  The economy of scale there is a step curve.  A lot of promoters will struggle finding these lessons out.  Some of the institutional funds do not feel the need to get into the rate race on the back end split.   So you see what looks more like a bond fund with the pref and the more desirable and successful funds don't have a split.  There are splits out there on the back end that are higher but investors and promoters alike need to put their reality caps on before they go chasing rainbows and unicorns.  

An interesting contrast to some of my points if I may, to the OP, @Paul C. 

It would be presumable that you dislike prefs of 8% or 10% as to not forsake the opportunity to earn more than that.  So what do you think keeps you content?  

Total Return of 12% or 15%?   

Let's leave the pref idea out of it for a minute.