Structuring a fairer future for private markets

Institutional and ultra-high net worth (UHNW) investors have always been attracted to alternative assets, which they use to diversify their portfolios and pursue appealing long-term returns. But retail investors have been shut out, limited by regulation and technological barriers.

Google search volumes for ‘invest in private equity’ (PE) have grown significantly over the past five years. This measure of mass interest proves that conversations around private markets are no longer just for investment industry insiders. A 2023 report from the World Economic Forum (WEF) revealed that 51 per cent of retail ‘non-investors’ would consider embracing alternative investments if given more opportunity.

This surge in interest is prompting a response from firms like Moonfare and iCapital, which are working to make venture capital, private debt, real estate, and infrastructure more accessible for individuals and their financial advisers. Market veteran Blackstone now has $8 billion under management from wealthy clients and described Q1 2024 as the “best quarter of fundraising from individuals in nearly two years”.

This conversation is important because more value is now being created pre-IPO, meaning less potential upside for public market investors.

Regulation: new structures ease the way

Rulesets like the UK’s Consumer Duty may be compounding the sense that investment product providers must handle retail investors only with kid gloves firmly on. But in reality, regulators are taking action to enable more investors access to private markets.

The revised European Long-Term Investment Fund (ELTIF) regulation – dubbed ELTIF 2.0 and effective from January 2024 – and the UK’s Long Term Asset Fund (the first of which launched in 2023) are both examples of efforts to create structures through which retail investors can invest in alternative asset classes. Moonfare has been among those to launch an ELTIF 2.0 fund, with the Alternative Investment Management Association forecasting €100 billion of flows into ELTIFs by 2028.

There is still now the matter of where these funds sit within retail investor portfolios. The UK’s retail investment landscape, for example, is heavily driven by which investments are eligible for inclusion in tax-efficient Individual Savings Accounts (ISAs). But LTAFs can be held only in the little-known Innovative Finance ISA (IFISAs): just £144 million was held in IFISAs in 2021/22, dwarfed by the £34 billion held in stocks and shares ISAs. Only time will tell whether this will lead to more savers opening an IFISA, or whether it will be a stumbling block for the success of the LTAF regime.

Liquidity: a square peg in a round hole?

Concern around whether funds containing unlisted assets are suitable for retail investors has been fueled by a series of liquidity crunches over the past five years, the most famous of which was the catastrophic collapse of the UK’s Woodford Equity Income Fund. The message from these episodes is clear: putting illiquid assets into a fund that allows daily withdrawals is akin to a square peg in a round hole.

It remains to be seen whether ELTIFs and LTAFs can effectively address this ‘liquidity mismatch’ issue. LTAFs, for example, have at least a 90-day notice period for redemptions and are required to invest at least half their assets in unlisted securities or other long-term assets.

For alternative assets to become an embedded component of the retail investor portfolio, a comprehensive liquidity ecosystem needs to develop. There is presently a lack of an established secondaries market for smaller private fund holdings, which again, the industry is moving to correct. Fintech platforms have emerged that offer a variety of transaction structures for investor-to-investor transactions, including open auctions, or partnerships with dedicated secondaries managers which offer investor-to-manager sale options. Moonfare is one example, and it allows its members to trade their fund stakes for cash in a formal process twice per year.

A fully-fledged secondaries market will require a degree of critical mass, with more small-stake investors leading to more liquidity. This market will need to be accessible online and via applications, and will likely need support from a dedicated third-party intermediary – potentially in collaboration with existing secondaries managers.

Technology: a crucial piece of the puzzle

Retail investors are used to a technologically enabled investment process from their experience in public markets, but the alternative asset investment process can be more complex, with frequent capital calls and valuations.

Data across alternative managers varies significantly. Each manager discloses different information on their investments and track record – and may use different methodologies to calculate this. Data platforms will be crucial in widening retail engagement with this market. They can help streamline the ingestion of data from various sources through application programming interfaces (APIs), consolidating the fragmented information spread across different managers and methodologies.

Technology to support onboarding, fund distribution, and reporting already exists and is used by retail investment platforms and digital asset investment companies. Blockchain technology and tokenised funds will also, in time, play a key role in providing access to private markets.

Education: the need for an IR rethink

WEF’s survey shows that education is a major barrier to investing, with 74 per cent saying they would likely invest more if they had more opportunity to learn about investing. This problem is likely to be compounded in private markets, given the dearth of public data and track record. Education needs to happen not just at the investor level, but also amongst their advisers and managers themselves.

Investors need to understand the difference between illiquid and semi-liquid investments, and be assisted in finding the right investments for their goals. Advice and oversight from advisers and intermediaries will play an important role here.

Meanwhile, managers need to realise that opening to retail capital means exposure to a new investor base. Investor relations strategies will need to be re-thought – with effective engagement with retail still an ongoing project in the public markets, where companies have centuries of experience.

Towards equitable access in private markets

With more than 75 per cent of Gen Zs and millennials saying it is not possible to achieve above-average returns by relying on traditional stocks and bonds, there is further need to establish fairer private markets participation for all investors. As the private markets continue to outperform many traditional investment avenues, ensuring equitable access not only promotes financial inclusion but opens further funding for entrepreneurs.

By refining investment structures and enhancing investor education, the private markets can become – more inclusive and bridge the current fundraising gap.

This article was originally published in Investment Week. You can read the original article here. 

About the author

Emma is IQ-EQ’s Group Chief Commercial Officer, based in London. With over 26 years of experience in financial service institutions, Emma has an established track record of delivering commercial business value in senior executive positions across the industry. She is passionate about sales, relationship building and focused on nurturing and expanding relationships with existing clients as well as diversifying the business mix by attracting new clients.