What is a fund-linked note, and when does it make sense?

How it works

A dedicated compartment subscribes to the fund, or to a basket of funds. It then issues notes to investors, and the value of those notes follows the value of the fund units the compartment holds, net of the compartment's own costs.

When the fund publishes its net asset value, the note is valued on the same basis. When the investor wants to exit, the note is redeemed or sold, and the compartment manages its position in the fund accordingly.

From the investor's side, nothing about the process looks like a fund subscription. There is no subscription agreement to sign with the fund, no investor questionnaire for each vehicle, and no separate account to open. It is a securities purchase.

The problems it solves

Fund-linked notes exist because a good fund and a willing investor often cannot meet directly. The obstacle is almost never the strategy. It is the format, and it usually takes one of four forms.

Open-ended and closed-ended funds work differently

The mechanics depend on the kind of fund underneath.

With an open-ended fund, the compartment subscribes and redeems units as investors enter and leave the note. The main design question is matching the note's dealing terms to the fund's: notice periods, dealing dates and any gates the fund can apply.

With a closed-ended fund, such as a private equity or private credit vehicle, the compartment makes a commitment that the fund draws down over time. The note can be fully funded at the outset, so that investors pay once and never face a capital call, or structured to follow the drawdowns. Fully funded is simpler for investors; following the drawdowns is more capital efficient. The right answer depends on who the investors are.

Who uses them

Fund-linked notes are most often used from two directions.

A fund manager or a distributor uses them to open a fund to investors who could not otherwise subscribe: clients of private banks with restrictive custody rules, smaller allocators below the minimum, or investors in jurisdictions where direct access is complicated.

An allocator, such as a family office or an external asset manager, uses them to gather exposure to one or several funds in a single, bankable instrument that fits the rest of the portfolio's administration and reporting.

What a fund-linked note does not change

The note changes the format, not the underlying investment, and it is worth being clear about what that means.

• →The risk is the fund's risk. If the fund performs poorly, so does the note.
• →Liquidity cannot exceed the fund's own. If the fund redeems quarterly with notice, the note cannot offer daily exits without a mismatch.
• →The valuation follows the fund's calendar. A note on a fund that publishes monthly is, in practice, a monthly-valued instrument.
• →There is an added layer of cost. The compartment has its own running costs, which sit on top of the fund's fees.
• →The note is a limited recourse obligation, backed by the assets of its own compartment and not by the issuer as a whole.

When it makes sense, and when it does not

A fund-linked note makes sense when there is a real barrier between the investor and the fund, and the cost of the extra layer is small compared with the value of removing that barrier. That is typically the case for private market funds, for funds with high minimums, or when several investors are aggregated into one position.

It makes little sense when the investor can already subscribe to the fund directly without friction. In that case the note adds cost and a counterparty without solving a problem.

For a broader comparison between issuing a note and launching a fund, see securitised note or fund . For how we structure these transactions, see securitisation in Luxembourg .