Morningstar Medalist Rating for Semiliquid Funds: A New Framework for a Converging Market

Laura Lutton: Hello, everyone. Thanks for joining today. I’m Laura Lutton, and I head Morningstar’s global manager research team. Today, we’re discussing the Morningstar Medalist Rating for semiliquid funds, which is an extension of the methodology that we use to assign Gold, Silver, Bronze, Neutral, and Negative ratings to traditional mutual funds, ETFs, and other managed portfolios. We’re looking forward to describing our plans to assign these ratings to semiliquid funds.

I’m joined today by two very accomplished colleagues. Karen Zaya is an associate director in manager research who focuses on multi-asset and alternative strategies. And Tom Nations is director of research products for Morningstar’s direct software platform. Now, before we begin today’s conversation, we want to take a minute to make sure you get the most from our presentation. Today’s webinar will be recorded and available on demand after the live session. All registrants will be emailed a link to the playback following the presentation. Lastly, you can ask our presenters any questions you’d like using the question button on BrightTalk or by leaving a comment on LinkedIn. After the presentation, we’ll address as many questions as we can get to. So let’s begin.

So first I’ll set the scene with an agenda. We’re going to talk about what semiliquid funds are in our view, why we’re rating them, how we’re going to rate these semiliquid funds, and then where to find them in our software. And again, plenty of time at the end to ask questions. So put those in the BrightTalk or LinkedIn fields as they occur to you.

So we’ll start with some definitions and why we’re aiming to rate semiliquid funds. So semiliquid funds refer to the vehicle that we are planning to rate. And it’s any offering that structurally constrains liquidity to the investor. These are often referred to from the private side as “evergreen funds” or “perpetually offered” funds. But in the US, for example, many US interval funds qualify as semiliquid. They typically allow investors to redeem up to 5% of assets a quarter. So this is a long-term investment. And the liquidity provisions may be different across different vehicle types, but to be sure, all of these do not offer daily liquidity like a traditional mutual fund or intraday liquidity like an ETF.

Many of these strategies or most of them incorporate quite a bit of private equity or private credit, and that will be an area of focus for our analysts as they begin their research to rate these. At the bottom of the slide, you’ll see some examples of the types of vehicles that we’re planning to apply this methodology to. So on the US, where we’ll start our ratings project, we’re focused initially on interval funds. But tender offer, nonlisted business development corporations, and non-listed REITs also fall in that semiliquid camp. In EMEA, we’re talking about LTIFs. In the UK, LTAFs. And then in Australia, semiliquid vehicles tend to be commingled with the traditional mutual fund universe. So those are some examples of some of the vehicles that this methodology will apply to.

So, why are we rating them? So these two charts show you US interval fund assets from March 2016 to February of 2025. And then on the right-hand side of the slide, this is a count of US interval funds. And you’ll see that once we get to 2021, there’s a bit of a hockey stick moment up and to the right, both in terms of assets and the number of offerings available. And we’ve seen a number of launches since we put these charts together at the end of February, so this is an area where we’re seeing not only investor interest but also product development from asset managers that are either established in the semiliquid space or are moving there.

So across our software platform, which Tom’s going to show you later, we track about 500 US-domiciled semiliquid funds. And these are being offered as a way for retail investors to get some private assets into their portfolios. And we’re seeing more and more wealth management firms suggesting that these be incorporated into client portfolios, particularly high-net-worth individuals. And we have found that investors and advisors really need more information and independent research to help assess these and decide if they’re good options for a portfolio. Now, the fees on these tend to be higher. And as we’ve mentioned, the portfolios are less liquid. It’s more difficult to find information on the portfolio attributes and so forth. But at the end of the day, our methodology is asking the question: Are semiliquid funds worth it?

So with that, I’m going to turn it over to Karen, and she’s going to describe in more detail how we’ll rate these funds.

Karen Zaya: Thanks, Laura. So, before we kick off with the methodology exactly, I want to get into the purpose and meaning here. So, these ratings are for investors and advisors who are interested in exploring these options. We’re not necessarily endorsing this as a wholesale “you should get into these just because we’re covering them” because our goal is ultimately to help investors determine if these are a suitable option for their needs and for their portfolios, and then to also provide an informed opinion on the best available options if they are deemed suitable. So we’re approaching these with an open mind, but with the requisite amount of skepticism any due diligence team should have. They’re not inherently bad, of course. They offer opportunity and breadth. But we do want to make sure that we properly set expectations to help prevent undue surprises. Like what really are the benefits here? What are you getting out of it? And then what are the true risks, limitations, and costs? So the approach, as Laura mentioned, is to ask: Is it worth it to deviate from a public market offering? Because semiliquid funds do have higher fees. They are less liquid as a vehicle, they hold less-liquid assets, and there’s less transparency.

And so what we would expect out of a Medalist or a recommended fund that receives a Bronze, Silver, or a Gold rating would be to outperform a public market equivalent index or a broad private benchmark. We also expect Medalists to outperform the Morningstar category index and a median peer because these are relative ratings, and you’ll see more coming out of our group later in the summer about categories.

And so I’d also like to highlight a difference from mutual fund and ETF ratings that this Medalist Rating has. For open-end funds, our Medalists indicate, like a Bronze, Silver, or Gold, an expectation for a fund to generate positive alpha after fees are taken out. Now, that tack presents a challenge in this harder-to-benchmark scenario. So rather than thinking about alpha above a benchmark, we’re thinking about excess return above the hurdles I mentioned earlier.

So the main steps to the rating follow where we score the pillars as we typically do, and we’re scoring the same three pillars: Process, People, and Parent. We account for fees, of course, so there’s an adjustment there, and then we use a rules-based system to assign the final Medalist Rating. And this equation is a guide because we invariably run into edge cases, so we do retain some discretion just to make sure the ultimate rating makes sense.

The pillar weights are different in this scenario, as they are for actively managed funds. So that second column with active funds, you have the typical Morningstar Medalist Ratings or the one we have so far is the Process is 45%, People is 45%, and Parent is 10%. So maybe the biggest difference to point out here is that we’ve added to Parent, which goes from 10% to 25% of the rating. And that’s funded from People, because when it comes to management, a firm’s capabilities to facilitate robust teams, partnerships, sourcing, and governance around the key elements to a strategy are so essential and maybe less a function of individual managers because of their reliance on shared teams in some instances. We’re recognizing that the broader resources have a bigger impact on key aspects of management in this context. And of course, the portfolio managers, the people, are still important as decision-makers, but they are relying on the broader ecosystem. And so that supports a smaller weight on People shifted to Parent. And then the Process rating has gone from 45% to 50%. And that reflects the added complexities and risks that are inherent to running portfolios with illiquid or private assets. And so I’ll get more into those considerations a little bit later.

And then I won’t bore you with the tedium of walking through this little scoring equation. But ultimately, we would score the Process, People, and Parents score on that same scale of Low, Below Average, Average, Above Average, and High. You plug that into that like 50% weight, 25% People, 25% Parent. And for a tiny example here, suppose a fund has an Above Average Process, High People, Above Parent, its score would end up being 1.25%. Then the way we would adjust for fees is that we group the funds into relevant asset-class-based peer groups, because we do find that private credit, for instance, tends to cost less than private equity. So we want to make sure that the peer grouping is appropriate. Then we compute an effective fee that uses a return assumption per asset class to normalize for fees because some funds and some vehicles have performance fees that kick in after a certain hurdle is met. And so we want to be able to rank those fund that do have performance fees against funds that don’t. And this will allow an investor and for us to compare private credit funds, for example, regardless of whether it’s an interval fund wrapper, tender offer, or nonlisted BDC. And so you get to approach the semiliquid universe as a whole, thinking about, say, private credit and evaluate them all side by side. So then we adjust the fund score by the fee rank. So the cheapest funds get a little boost to their score, average cost funds get no adjustment, and the costliest ones get a deduction.

And then this slide provides the kind of breakdown and ranges of what constitutes a Gold, Silver, Bronze—those are the recommended ratings—and then a Neutral and a Negative. And suppose Fund A had low fees. Its prefee score was 1.25. Low fees gets it to a 1.5, which would result in a Silver rating just based on the range and then also the fact that none of the pillars were rated Below Average or Low. Then this is a snippet of the ratings table that shows the combinations of the pillars and the fee ranking and how they result in the Medalist Rating here. Fund A, that example that I’ve been walking through, is the third row from the bottom, and because it had High People, Above Average Process and Parent, cheap fees, and so it got a Silver rating.

Now, let’s talk a bit about the pillars. And so this is also, this is the area where we do really kind of expand on our process here. So when we’re rating the pillars, we are expanding on this approach that Morningstar has refined over years, and so the additional considerations for Process, for example, are multifaceted, but I’ll walk through a few. The first I want to talk about is the alignment of the vehicle’s liquidity provisions, like the actual wrapper, a tender offer fund, or an interval fund, with the liquidity of the portfolio holdings. So this is something that already comes into play with mutual funds and ETFs we rate. But we need to have a little bit more careful analysis or that analysis is amplified when you start getting into private assets, which are less liquid than what you see in typical mutual funds and ETFs and that also occur at higher doses than you would see in a mutual fund or ETF. So you have more asset-class-based liquidity hurdles to overcome here.

We come at that from a couple of different angles. First, are the holding’s liquidity profile a good match for the vehicle? So, for instance, maybe an extreme example, maybe not, is would you want to see private equity in an ETF? Maybe an ETF, which offers intraday redemptions—or, you know, you can exchange in and out of it throughout the day—that might be a bit too liquid for a portfolio that’s holding a lot in private equity. Those because that asset class itself is not liquid. And then in the other direction, are the assets too liquid for this vehicle? Like, would you really want to see an interval fund that holds public equity? You would have to evaluate, why would I give up liquidity from the vehicle standpoint to invest in something that I could get in a mutual fund or ETF just as effectively and for less fees and so on.

Another area of focus for us will be the valuation methodologies. Since the assets are nontraded, people rely on valuations to price the assets and so what we want to know and evaluate are: Where are valuations sourced from? Are they in-house? Are they third-party independent or both? At what proportions are these combined and put into place? Is there a valuation committee, and how does that committee function? How multifaceted is the valuation methodology? Is there evidence that a manager consistently under or overvalues holdings? Another consideration on the private credit side would be we’d want to understand the workout process of a team. So when things go wrong for an investment or a holding, what’s the process by which a team works to recover or preserve the most amount of value for the strategy? We would be looking at underwriting processes, and so this is about how sound the due diligence is on the various investors or deals that the managers source. And then also how well has the liquidity been managed? Has the fund had to gate redemptions? Why? And so on.

Then for the People Pillars, we’ll be looking at the kind of typical considerations and then additionally, we want to know about the composition of various additional teams that are important when you are incorporating private assets or dealing with these different wrappers. For instance, the deal sourcing teams, the underwriters, originators, exits and workout teams, and then the investment and valuations committees, we want to know about their experience, tenure, how they function together, and serve the strategy in question.

Then with the Parent Pillar, the firm’s experience and abilities in illiquid assets, private or not, warrants additional consideration. Then very importantly, well, there’s a lot to it, but I’ll just highlight a couple of things. The governance processes relating to the allocation of deals across funds, the valuation methodologies, the exit processes, these are all considerations here. We want to know about the fundraising record and evaluate the kinds of partnerships and talent that the firm can attract and retain—and are those things that can go on an ongoing basis? Our near-term plans are to rate interval funds coming up in the third quarter. We’ll release our first batch of ratings. Then we’ll have a second wave of ratings in the fourth quarter. You’ll see similar write-ups in structure to what we do for mutual funds, but you can expect a little bit of a different discussion focus on what’s important and critical here, like the different aspects of Process and People I mentioned. Those will be analysts-covered only. We’re not going to have stars on them or quant ratings. And now I’ll hand it over to Tom to let you know about how to find the interval fund universe.

Tom Nations: Great. Thank you so much, Karen. Appreciate it. So I’m just going to walk through a quick video demonstration to show you all where to find this content in Direct. Starting with the article, the primer article that Karen published introducing the Medalist Rating for semiliquid strategies, which is included in the attachments as part of this webinar. I just start at the top by saying we’re sort of aligned as a company on bringing transparency to this space. You’re going to see more and higher-quality data in some of these vehicles. You’re going to have our differentiated independent research voice that’s part of this Medalist Ratings and then our product capabilities to bring that to life in our software like Direct.

So clicking on that link within Karen’s primer article takes you into the web experience of Morningstar Direct. It’s available for all Direct users at direct.morningstar.com. You can see how we went about identifying the interval funds that are available for sale right now in the United States with that search criteria. On the left-hand side, Laura talked about seeing roughly 120 strategies as of February. This search criteria is dynamic. It will update based on new launches and new activations in our database. As of yesterday, when I ran this recording, there were 143 investments in the integral fund database. This is available for all users. This isn’t walled off anywhere. Again, this is available in our Morningstar research folders that are available in the new experience as well as in the desktop experience as well.

So you see we have the data kind of laid out in a way that is relevant to the interval fund database, right? So we have a pretty clear story in terms of where we’re going with the dataset and how we’re leveling up the data that goes along with it. Starting with sort of the basic instrument and disclosure data that we’re collecting from N-PORT filings and other regulatory filings. Adding derived analytics like categorization and risk and performance metrics and now adding our own proprietary ratings as well. There’s specific data in here that is also relevant to the interval fund database, right? So there are questions about performance incentives and fee structures and things like that that came through the chat. You can see this all within this interval fund data view that kind of showcases how we’re collecting this information, how we’re organizing it, and then providing it at the specific security level database. This is all sortable. It’s navigable. You can all find it within the product itself.

So the first way I showed you to get through it was through Karen’s article. Again, this is also available for all users via Morningstar Direct. So if you go into my library of the new experience, open up the search criteria. You will see Morningstar Research folders divided by region. That’s where we’re going to keep delivering more and more content and underlying analysis from our research teams. You see strategies divided by the tender offer and interval fund universe, again, created by our research teams. That’s how you can access the interval fund universe here as well. The data can be edited. You can bring in your own datasets, your own views, what’s relevant to you across our entire Morningstar database and bring in more and more data and customize the view to meet your own needs. You can build specific lists off of this, build reports and things like that. Again, this is where you’re going to see more and more data and more IP in the space. Especially when we have things like the Medalist Rating, which we’re all very excited about, that will obviously be front and center in this view when that goes live in Q3.

That’s a quick demonstration of how we’re going to showcase this data and how we are showcasing this data in Direct. Now we’re going to open a quick poll to kind of show, you know, ask questions about those that are interested in Direct. And I will pass it over to Laura to moderate our Q&A. I know there’s been some great, great questions in the chat.

Lutton: Thanks, Tom. Yes, lots of questions. Thank you for your engagement. So I introduced some confusion with my chart showing those interval funds, about 120, 130 as of February, and then later on mentioned that we’ve got about 500 that we’re tracking in Direct. Do you want to give us a breakdown, Tom, of kind of how those universes or types of illiquid, semiliquid strategies are showing up?

Nations: Right, yes. So in your introductory slide, you kind of talked about how we group and how we’re viewing semiliquid, not as a monolith, but there are all these different vehicles that roll up into the semiliquid space. The 500 strategies that you mentioned in terms of how we’re tracking that comprises in the US interval funds, which we still are 143, for those that are following along in Direct, you could open the tender offer universe right now and see 71. The remainder is made up by unlisted BDCs, which we talked about as well as private REITs to get to that 500 plus figure that we can track in Direct.

Lutton: OK, great. And do you want to talk about how, down the road, folks can find these in Direct in terms of universes beyond those lists that you shared?

Nations: Yes, so in the future, we’re going to be launching an investment discovery project. There was a question about interval funds existing solely in the closed-end fund database. That’s part of the reason why we have those universes available in the Morningstar Research folders. Again, those are available for all direct users. In the future, it’ll be much easier to see where these strategies are and how they’re organized so they’re not into these broad open-end closed-end fund groupings. But you can start on the homepage and then dive into, “I want to see how Morningstar is tracking in the tender offer space,” what we’re tracking in the interval fund space. And it’ll be much more apparent as to where to actually find that information in Direct.

Lutton: OK. So if you’ve been looking for these strategies in the closed-end universe and so forth, they’ll all be centralized in one place in the coming months.

Nations: Yes, exactly.

Lutton: OK, perfect. Karen, a couple questions for you about methodology and process. So one of our questioners notes that semiliquid offerings often include incentive fees, and how are you going to treat those in your assessment of fees?

Zaya: Right. In order to account for the funds that do have incentive fees, we’re going to plug in a expected rate of return that depends on the asset class, and that will give us like kind of a forward-looking expectation of what an investor would expect to pay over time on average. It’s like an average effective fee, and then that will also allow us to rank those funds that do have incentive fees against ones that don’t.

Lutton: Great. Then we also had a question about whether you’re going to be meeting with the managers and perhaps firm leadership associated with these strategies, or are you just going off of public documentation to assess the funds and their teams?

Zaya: We will be meeting with the fund managers and firm leadership in order to get a deeper understanding of how the teams function, what their processes are, how they think about their approaches and opportunities and the risks. That is a really great aspect to our process where we get to have those conversations and kind of put together the data along with the kind of indications from leaders and portfolio managers about how these things work.

Lutton: OK. And if you’re maybe participating in this webinar from a firm that’s offering one of these funds and you’re interested in making contact with the research team, how best to do that?

Zaya: So there is a link, I believe, that we’ve provided as part of the supporting materials to this webinar where an investor or a firm, an asset manager, or anyone can suggest strategies to be rated, and that we’re always keeping an eye out, and we appreciate that input from people about what’s important to them to see what else we should look out for.

Lutton: Great. OK, let’s go back to Tom for a second here. Tom, we’ve received a question about PitchBook data. I know there have been some recent additions to Direct in terms of PitchBook data. How would you describe the collaboration between PitchBook, which Morningstar has owned for almost a decade, and the traditional Morningstar software experience?

Nations: Yeah, absolutely. I mean, I think you could simplify it at a high level that Direct has been the platform for the traditional, more liquid, more retail sort of vehicle structure, open-end ETF, individual securities that are publicly listed. PitchBook historically has been that institutional, more private asset focused platform. And then you sort of have this middle ground that we’re talking about here where we’ve seen a lot of growth in the space, right? And so we need to bring those two datasets together to properly understand what’s going on in the space. And that’s where you see partnership from our research team in terms of collaboration and connecting with that.

On the Direct side, we have brought in the private capital funds within PitchBook’s database into the software, so you can now review and sort through that sort of structure. Again, because this is sort of a middle ground, we’re not talking about necessarily capital call vehicles like the general GP-, LP-focused strategies that PitchBook goes after. It’s sort of a combined data and research effort that the two platforms, Direct and PitchBook, are working together to bring to life across both. So we are partnering with PitchBook certainly on that front in terms of leveraging their expertise, both on the data and research side, but then bringing the data to life on the semiliquid side in Direct.

Lutton: Great, thank you. Karen, one of our participants today has noted that a lot of the methodology that you described is qualitative, but we do have some new quantitative tools coming. Specifically, we’ve been asked whether we’ll have percentile ranks by category, perhaps category averages, star ratings. What’s the plan on the category side?

Zaya: Sure. So on the category side, we will be rolling out maybe a “reorganization” of the semiliquid funds is what I’ll call it, because they already have categories within our system. But so we’ll be putting out new categories that bucket them kind of in, I would say, useful ways to kind of think about the strategies and when an investor is approaching them. Once they do have those categories redefined, we’ll have category benchmarks, we’ll have category averages and medians, and like clear-cut peer groups where you can kind of like evaluate an investment against its relevant peers.

Lutton: OK, and then another data-related question: How are you going to benchmark these semiliquid funds relative to maybe category or other criteria?

Zaya: I’m going to rewind back to the idea of—is it worth it? Because you should evaluate these from the perspective of: Why should I deviate from something that’s cheap and super liquid and super transparent and go into this other situation? And so one of the primary ways we’re going to benchmark and evaluate is by comparing these strategies to a broad public index. That is like an approximate kind of exposure, you know, that like this is another option that’s public that you can get. And so we’ll have a primary public index. Then we’ll also kind of look at, are there any secondary indexes that speak to this specific return profile? And then these are relative ratings, and so we’re going to look at that peer median as well.

Lutton: OK, Karen, I hear your cold talking there. So we’re going to go back. Last question is for Tom. Any new data points coming that you’re excited about related to these?

Nations: Yeah, certainly. I think that’s something that we are actively building out these datasets and make sure that we do have that sort of collection data as well as the derived IP that comes off of that. So when you look at the interval fund universe, again, you’ll see both two things that are constantly updating. One is the securities that are launched and activated, the security-level data will be coming, as well as new and improved data that comes alongside of it that will then feed into Karen and her team’s research and analysis that will go into the Medalist Rating as well. So this is certainly an area, again, we’re building out our collective experience there, and we’re going to add more and more data there so that users can constantly go back and see new things across this semiliquid space.

Lutton: OK, great. So I’m going to hold us there. We’re at time. Thank you so much for joining us on this webinar. Again, the recording will be available, and we look forward to hearing from you. Thanks so much.