Morningstar Exposes Shocking Truth: Are Semiliquid Funds Really Safe? Investors MUST Know Now!

A recent report from Morningstar, titled "The Role of Semiliquid Funds in Portfolios," challenges the conventional wisdom surrounding private market allocations. The report asserts that semiliquid funds, which are designed to offer investors some liquidity while investing in private equity or private credit, do not effectively serve as diversifiers in traditional investment portfolios. Instead, financial advisors should view these funds as extensions of their clients' overall equity and credit allocations.

This perspective contradicts a key point often emphasized by financial advisors. According to a 2025 survey conducted by alternative investment platform CAIS and financial consulting firm Mercer, a significant majority of advisors allocate to private debt, real estate, infrastructure, structured notes, hedge funds, and natural resources, primarily because they see these assets as risk diversifiers. In contrast, private equity and digital assets are primarily viewed as “return enhancers.” The survey revealed that 67% of advisors utilize interval funds to access private assets, with 54% opting for private placements, 46% investing through Business Development Companies (BDCs), 36% allocating to non-traded Real Estate Investment Trusts (REITs), and 31% relying on tender offer funds.

In an effort to improve transparency regarding the performance of semiliquid vehicles, Morningstar, along with other market players such as XA Investments, has initiated several measures. Last year, Morningstar launched the Morningstar PitchBook U.S. Evergreen Fund Indexes, which track interval funds, non-traded funds, BDCs, and non-traded REITs, and began assigning Medalist ratings to evergreen funds. Additionally, XA Investments introduced the XAI Interval Fund Index, which monitors 77 interval and tender offer funds.

However, the report emphasizes that to fully benefit from semiliquid funds, investors must commit for the long term—typically a minimum of seven to ten years—despite the liquidity features these funds offer. Interval funds generally provide monthly liquidity windows, but impose caps on monthly and quarterly redemptions. To justify this duration of illiquidity, investors should anticipate returns at least 2% higher than those provided by public markets. Yet, as Chris Tate, a senior analyst at Morningstar and one of the report’s authors, notes, determining how often semiliquid funds achieve these returns remains complicated. Notably, over half of all interval funds have been in existence for less than three years. While semiliquid funds may appear to yield higher returns, this can sometimes be misleading; for instance, greater leverage can artificially inflate returns for semiliquid funds that focus on private credit, compared to those investing in syndicated bank loans.

“The overarching message would be to make sure people consider all the pros and cons and go eyes wide open into it,” said Tate. “Make sure the assets, and particularly the vehicle structure, are right for the clients’ circumstances.”

Tate further cautioned that semiliquid funds could increase a portfolio's volatility. Because private assets in these funds are not frequently priced like public market assets, gauging their true volatility and correlation with public markets can be challenging. Consequently, investments in semiliquid funds may appear safer and more diversified than they truly are. Adding to this concern is the fact that semiliquid funds often come with higher fees, which can diminish potential returns for investors. Morningstar data indicates that the prospectus-adjusted expense ratios for interval funds and tender offer funds average about 2.7% and 3.9%, respectively, in stark contrast to the average prospectus-adjusted expense ratio of just 0.6% for a U.S.-listed ETF.

Given these factors, advisors are encouraged to reevaluate how they view private market allocations. Rather than treating them as a distinct category, advisors should consider them as integral parts of their clients' overall equity and credit allocations. It's essential to establish portfolio performance construction goals first—focusing on aspects like real returns, income, or capital preservation—and then assess how much illiquidity their clients can tolerate, their time horizons, and their risk appetite. Only with this groundwork can advisors allocate to semiliquid vehicles that align with these predetermined criteria.

“Instead of a 10% allocation to private equity and private credit, the question is how much equity and credit risk do I want to allocate to? How much illiquidity risk am I being paid for?” Morningstar researchers stated. “Private equity is thought of as levered equity risk, long-duration growth exposure, and the illiquidity premium. Meanwhile, private credit is viewed as credit risk plus an illiquidity premium and shorter duration. Capital is not allocated based on prescribed asset-class budgets, but on marginal contribution to the total portfolio.”

As the landscape of investment strategies continues to evolve, these insights from Morningstar present a timely opportunity for financial advisors to reexamine their approach to private market investments, ensuring they align with their clients' broader financial goals.