Why Semiliquid Funds Cost More than ETFs

Private market investing is attracting more investor interest, but higher returns don't come free. The challenge for advisors is understanding whether the costs associated with semiliquid funds are justified and how those costs can impact client outcomes over time.

In this conversation, Morningstar's Jack Shannon examines the fee structures driving semiliquid fund expenses, highlights key disclosure gaps, and shares insight into evaluating these strategies. Watch to learn where costs can hide, why fee structures matter, and what questions every advisor should be asking before recommending semiliquid investments.

Explore the full report, The State of Semiliquid Funds 2026, to get Morningstar's outlook on:

• Semiliquid fund fees
• Private equity and private credit trends
• The competitive landscape
• Private markets coming to 401(k)s
• The role of leverage in semiliquid portfolios

Brian Moriarty: Semiliquid funds are more expensive than traditional mutual funds and ETFs. We know that. But just how much more expensive and where are those additional costs coming from?

Jack Shannon: This is Morningstar's favorite topic to talk about and asset managers' least favorite topic to talk about. Yes, they are significantly more expensive than mutual funds or ETFs that the everyday advisor, everyday investor might be used to. And as you can see on the chart here, they're more expensive by multiples. And importantly, these are likely understated.

So if you think about what a lot of these funds are doing, you know, maybe the private equity strategy that directly owns a company in its fund. A lot of these funds aren't doing that. They're owning underlying funds. And so those are layers of fees in here that are sometimes fully rolled up to the parent level in the acquired fund fee. Sometimes not fully rolled up. Sometimes incentive fees get included. Sometimes they don't get included.

So I think what investors should care about is, you know we've done a lot of research on the public asset side about how fees are the number one determiner of outcome in terms of how well a fund is going to do relative to its peers. That's certainly going to be the case here.

Shannon: I think investors really need to realize that the sticker price here is still probably understated. And that means if you're buying one of these for the idea that you want to beat a public market, they have a high hurdle now, right? Because if it's 4% or 5% and that's maybe understated by 1% or 2%,  these managers are going to have to deliver a lot of excess gross return in order to make you whole relative to public markets.

So we've got our framework, which I'm sure we'll talk about later in terms of how we rate these strategies, but this fee piece underlies a lot of our framework in terms of why maybe we have a conservative bent to our ratings. It's because we see a very high hurdle that has been created in terms of the fees.

Moriarty: Would it be fair to say that as disclosure improves, we might actually see the headline fees or the disclosed fees go up before they start to come down, if or whenever fee competition kicks in?

Shannon: Yes. I mean, that'd be a good sign to us actually. If fees go up, that means they're actually disclosing them better. 

Shannon: So, we see this on the incentive fee piece. We published some research earlier this year that was highlighting how a lot of the unlisted BDCs, which are a lot of the private credit direct lending strategies, they had an incentive fee line in their prospectus, but they didn't have any value in it. Now, we did a bunch of research to show that these incentive fees are collected continuously. There's almost no scenario where they won't be collected. So, we put some research out saying it was basically ridiculous that they weren't putting these in their prospectuses. And lo and behold, a few weeks later, they all started filing new prospectuses with these incentive fees included.

So yeah, I think the next area for that would be the acquired fund fees because again, as I mentioned, that's an area where there's a lot of gray area there. And until that can be compared apples to apples, I think it just makes it really hard for investors to get a handle on what's expensive versus what's cheap. We're working on some things we'll get into later to help help solve that.

Moriarty: I have a question on the acquired fund fees, but before we do that, if you could take a minute and explain, you mentioned incentive fees and and how that's one of the reasons for why these are more expensive. There are two kinds of incentive fees roughly. Can you talk about those two, maybe income versus capital gains, and are they adequately, inadequately disclosed? You mentioned that a moment ago, but also are they appropriately structured?

Shannon: Let's start with just the basics. So, yeah, there are generally two forms it comes in. It comes in the income where if they're making loans and they're collecting interest, they will charge a fee on the net investment income of the fund. If you do that, you don't have to restrict yourself to these higher accreditations. So if managers want to push themselves downstream and continue to collect incentive fees on income, there are very few barriers to that.

Whereas if you want to do it on capital gains, which is the other form you can capture these fees on, then you have to restrict yourself to higher accreditation limits. So that's that piece. 

In our view, a lot of these are not structured all that friendly. I mentioned earlier that if you really do the thought exercise on when will they not collect their incentive fee, especially on the income piece, it's rare. You need rates to go to zero and you need lending spreads to compress considerably, and you need leverage to compress considerably. And all three of those things happening at once I think would be a very fringe scenario, so that's the credit side.

On the equity side, most of these don't have any hurdle rate. So they're just collecting fees on unrealized gains and maybe some do it on realized gains, relatively few. But they're just collecting any net profit they have on any markup they make, which we don't love. We think incentive fees are not a bad tool. I think they can align interest between investment managers and fund holders by aligning best risk-adjusted returns going forward. But when you have no hurdle rate, or even a low hurdle rate in the case of equity where equities return 10% annualized over 100 years and you have a 5% hurdle, we'd probably still argue that's still pretty low. We have no problem with them, we just think they can be structured in a more investor-friendly way. 

Moriarty: Can you just briefly talk about the distinction between charging a capital gains incentive fee on realized versus unrealized?

Shannon: Yeah. So a lot of these private equity funds, they hold something but they but they don't sell it for years, right? Because this is not something you can trade. So if they want to collect incentive fees, they can collect them one of two ways. 

One is you charge on the unrealized gain as you keep marking that position up, which a lot of times that's what happens. Or once they sell the asset, then they collect the incentive fee on whatever was actually realized. 

We would prefer the realized option because that's the real cash that's actually coming into the fund that you can then take your fee on. However, there are issues with that too. It's not like there's a clean solution because depending on when you buy into the fund, you could be paying this incentive fee on this big realized gain that maybe you just bought into last month and you didn't actually get to experience that gain, but now you're getting hit with the full fee.

So there's weaknesses to all of them. We just think that no matter what they choose, it could be a tool to align interest, but it needs to be structured in a way that actually allows that to happen, which we don't feel like is the case in most of these.