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Democratising private markets: opening up the promised land?

17 May 2023 | 6 minute read

Alternative assets have grown in popularity over the past couple of decades and are due to reach a staggering $17.3tn in 2025, according to Preqin’s latest Alternatives Report. While alternative assets have been commonplace for institutional investors and the ultra-high-net-worth (UHNW) community, providing them with the means of diversifying their portfolios and achieving attractive returns, this has yet to reach the retail audience. 50% of UHNW investors have investments in this asset class, compared to just 5% of retail investors.

With inflation rates rising and public markets volatile, retail investors (those not fulfilling the FCA criteria as a sophisticated investor) are searching out new avenues for increased returns. As a result, the alternative funds industry is increasingly looking to welcome retail investors to the asset class; an EY and SEI survey shows that 73% of managers believe non-accredited investors should be able to invest in private markets. Recognising the potential, regulators across the EU, US and UK are also responding to create a regulatory framework that promotes accessibility and protection for retail investors.

Drivers for new market participants

As rising inflation continues to increase interest rates, retail investors are looking to diversify their portfolios to protect themselves from unpredictable market conditions. Unlike listed equities and debt, alternative assets tend to perform well against inflation, due to their longer-term investment horizon and potential double-digit annualised returns. With the backdrop of unpredictable market conditions, retail investors are increasingly seeing the benefits of the asset class characterised by high risk-adjusted returns and the opportunity to diversify their portfolios.

While fundraising from institutional investors remains strong, asset managers have said the amount of capital raised from institutions is slowing from record highs (see Preqin). As a result, fund managers are exploring new roots to capital, of which high-net-worth (HNW) retail investors alone could provide approximately $1.5 trillion worth of AUM by 2025, according to Morgan Stanley’s recent Wealth & Asset Management: Competing for growth report. If the allocation of capital from institutional investors continues to diminish, the increased appetite for retail investors in the alternative asset class could help fill the funding gap.

The benefits of private markets has also been recognised at the portfolio company level by company founders and CFOs alike, as companies are remaining private for longer, opting for an increased number of funding rounds before an IPO. According to NASDAQ, in 1980, the median age of a company at its IPO was six years, whereas in 2021, the median age was 11 years. This trend suggests that if retail investors want access to new innovative companies and their growth, they will need to increasingly look to the private markets.

The benefits of retail investor participation are clear; however, the execution provides significant challenges.

Watch out: challenges ahead

Although much has been made of the benefits of opening private markets up to retail investors, it’s unlikely there will be a “big bang” opening in this regard. Education will be key to ensuring that democratising the private markets is a success. Investing in alternative assets presents various complexities and challenges, many of which retail investors may not understand – such as the long-term lock-up period, the complex management fee structure and lengthy investment documentation. Therefore, fund managers and their investor relations teams must ensure they are providing educational and informational resources, expanding offerings with fund structures more suited to retail investors, and rethinking policies on transparency and information sharing to avoid misleading investors and potential regulatory fines.

Anti-money laundering and know your customer (AML/KYC) is also critical to making this trend sustainable for both the investor and the fund manager. Today, private funds may have a handful of large institutional investors; in the future, they may need to onboard and maintain thousands of smaller, retail investors. The current manual operating processes that are commonplace in the industry will soon become unsustainable as the industry is accessed by a higher volume of retail investors.

For the investors, those who are used to investing through private wealth, defined contribution or 401(K) pension platforms have come to expect efficient, digital experiences from onboarding through to reporting – thus moving to a lengthy process, including various subscription documents and forms, is unlikely to satisfy their expectations.

This wouldn’t be a future-facing article without mentioning blockchain technology and the tokenisation of funds. Technology and new concepts such as blockchain and tokenisation could provide the necessary solution to both reducing paperwork and providing easier liquidity mechanisms to invest and divest LP stakes in funds. In a recent report, Bain & Company noted: “Digital tokens have the potential to transform how private equity funds raise and administer money. They could open up pathways to wealthy individuals and hasten the development of more-liquid fund formats. They could also lower administration costs and make fund operations more efficient.” Such technology can allow fund managers to tokenise products for retail investors at lower minimum ticket sizes as well as providing a more sound, robust and scalable operational process, allowing for more seamless secondary transactions and more efficient AML/KYC.

Reporting has also long been a challenge across the alternative asset class, in terms of ensuring performance, fees and asset-level information is readily available for reporting to increasingly demanding LPs. The participation of retail investors, who aren’t necessarily familiar with the traditional quarterly reporting cycle and level of information granularity provided, will only heighten the challenge. Investor relations teams are concerned about the potential overwhelming volume of bespoke information and data requests, which were traditionally the reserve of cornerstone institutional investors but now could be required for thousands of investors.

Technology is king

New technologies are critical to truly democratising private markets and to making it easier for individual investors to access alternative assets. White labelled investment platforms are already starting to disrupt the market and allow crowdfunding and investment decisions to be made from just a smartphone. With technology helping to automate onboarding and subscription, and simplify AML/KYC checks with face recognition, investors can now open a new account in five minutes.

Distribution platforms such as Moonfare and iCapital, as well as fund administrators, also have a role to play in supporting fund managers and investors by not only digitising this experience and the flow of data, but also aggregating both investor onboarding and reporting. Digitalisation also means communication between the investor and fund managers is more efficient, as information can be shared in seconds, rather than days, ensuring investors have more time to make investment decisions.

All in all, technology is helping improve the investor experience in the private capital industry by increasing efficiencies to ensure a smooth entry for retail investors into the market. With new market technology transforming the norms of the industry, jurisdictions are beginning to draft legislation to ensure regulation doesn’t lag behind.

What comes next for the industry?

It is likely the democratisation of private markets will be phased in its approach. There is a natural progression of HNW individuals and family offices continuing to grow their private markets allocation, while the regulatory and technology frameworks needed to support a broader democratisation to retail investors.

Across the globe, regulators are exploring – and in some places implementing – frameworks to support retail investors while still maintaining an appeal to institutional investors. In 2020, the US’ SEC broadened its definition of ‘an accredited investor’ to allow more retail investors to participate in private offerings. On the continent, the European Commission unveiled its proposal to amend the first version of its European Long-Term Investment Fund (ELTIF) regulation, which removed the €10,000 minimum investment ticket. Finally, the UK’s FCA recently revealed a proposal to amend the Long-Term Asset Fund (LTAF) regulation; of which, the final two amendments will make access to assets easier and more flexible for both professional and retail investors.

Although the industry is still in the infancy of democratising private markets, progress is already clearly being made both on the technology side and also for GPs, with several fund managers beginning to lower the minimum ticket at which investors can access its products.

For now, private wealth remains the most frictionless avenue for fund managers to access retail investors, with the support of private banks and investment advisors playing the role of distributors as part of a broader portfolio, but it is clear for investors and fund managers alike there are vast untapped opportunities within the retail investor base.

Working with IQ-EQ has been seamless – you and your team understand our business, advise us appropriately, and handle your side of our collective partnership so that we can focus on making good investment decisions. Evan Gibson SVP, Merchants Capital

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