Piecing together the puzzle: how to open up private markets to individuals
We’ve waxed lyrical about democratisation before and our dislike for this particular misnomer, with all its inherent implications that all ‘democratisation’ really requires is access — facilitated by technology.
In reality, opening up the private markets is more of a jigsaw puzzle. Technology helps, yes (full disclosure, we’re a tech vendor) but the legal and regulatory structuring of the investment product and the ability to operate those products at scale are arguably more important.
Since the early days, private markets have been almost exclusively geared towards institutional investors, which means fund structures and their operations have largely stayed the same. Great when all your investors are uniform, but add hordes of individual investors into the mix and this archaic system with its weighty admin requirements quickly runs out of track.
Private wealth represents a huge growth opportunity for our industry, and asset managers looking to capitalise on it need to diverge from structures, terms and conditions that were designed for (and only really suit) institutional investors. This is something Partners Group (PG) cottoned on to 20 or so years ago — the firm manages the largest and longest-standing private equity fund for private individuals regulated by the Securities and Exchange Commission (SEC), as well as equivalent funds in Europe and Asia. Hedgehog co-founder and PG alum Rob Lamb invited four previous members of the PG structuring team responsible for those market leading products to sit down for an informal chat about how far the industry has come since those days… and how far we still have to go.
Aside from myself (Stephen McConville), others joining us at the table were:
- Pictet’s Jane Griffin
- Bellevue’s Chris Davies
- Michael Wehrle from Blue Orchard (Schroders)
Are private markets ready for the masses?
The resounding take from our experts on this one was, not yet… but the regulatory piece of the puzzle is rapidly taking shape.
In Europe and the UK, recent regulatory developments — the European Long Term Investment Fund (ELTIF) 2.0 and Long Term Asset Fund (LTAF), respectively — now provide a framework for distributing private markets to retail investors.
Michael Wehrle: “The fact that they’ve recently upgraded the ELTIF to reflect feedback from the industry is part of the shift towards opening up the private markets, from a regulatory standpoint at least. This is not just repackaging structures that already existed, but designing new ones for a new group of investors. Ultimately, the structuring solution needs to be different models for different segments of investors, otherwise it’s hard to see how to overcome the operational burden on fund managers. Imagine if they have to approach hundreds of small investors every time it comes to a capital call.”
Jane Griffin: “ELTIF 2.0 is not perfect, but it begins to get close, with a staggering amount of industry feedback incorporated into this new version. Let’s not forget, it remains the only blanket non-professional marketing passport for the whole of Europe, although operationally it’s not easy (yet).”
Are operations a stumbling block?
So regulation is taking shape, but distribution is still a constraint — and operational issues and a lack of flexibility in traditional channels sit at the heart of that.
Opening up the private markets to more investors generates no small amount of paperwork. Onboarding, subscriptions and payments need to be handled individually for each investor; not a problem when you’re dealing with relatively small numbers of large investors or smaller investors aggregated in a nominee vehicle, but far from manageable with large numbers of smaller individuals investing directly.
Stephen McConville: “I think most managers recognise that they need digital solutions if they’re going to make the most of the retail interest in private markets, and manage large inflows and outflows from private wealth. Those solutions need to be compatible with the ‘gatekeepers’ bringing individual investors in — banks, pension platforms, eventually even robo advisors — which are all set up differently.”
Jane Griffin: “There are currently very few distribution platforms that can handle the commitment model, providers are often only able to add their paid-in share classes, cutting individual investors out of drawdowns completely. The legislation has come a long way with things like the ELTIF, but we need the operational setup to match the legislative move in order to achieve any scale.”
Chris Davies: “For a retail base or semi-retail base, the liquidity profile is also important to have, and for that you need a multi-asset matrix that allows you to proportionally allocate here and there. Obviously you can’t guarantee liquidity, but at least you have fairly flexible liquidity mechanisms that keep these platforms reasonably happy.”
Rob Lamb: “There are lots of people interested in distributing private markets investments to individuals. But getting it right from an operational perspective? There’s no shortcut for that. You could be a top quartile fund manager in any area of private markets with a track record that would fit very well in the end portfolio of an individual investor, but distributing your fund using an appropriate structure via existing distribution channels in a way that is scalable and efficient is probably beyond you. And 90%+ of private wealth still flows through those channels today. For most of the industry, that means individual investors are still out of reach.”
So, what’s the solution?
Chris Davies: “I think the next year is going to be really interesting. Right now, in this environment where there’s a bit of a liquidity crunch, cheap debt has gone, exits have slowed, IPOs are non-existent in some areas… private markets are definitely eating into the public markets and hedge funds, and so there’s a massive desire there to get access to these higher risk-adjusted returns. I think some of these platforms, and other participants that are not so familiar with private markets, will be on a steep learning curve.”
Stephen McConville: “I agree. There are some foundational elements here that are going to be table stakes — meeting the operational burden, managing risk, facilitating commitment models, increasing access to liquidity, and educating investors — all are critical if we’re to meaningfully open up private markets to individuals and fulfil the potential offered by the recent legislative progress.”
With the current volatility in public markets it’s easy to fixate on these short-term needs, but increased demand for alternatives will outlive the bears. Preqin put the value of alternative assets under management at over $13tn at the end of 2021 and expects it to reach $23tn by 2026.
Rob Lamb: “I think everyone agrees that private wealth is the next potential growth engine for the industry as a whole, and realistically digitalisation is the only way we can support and facilitate this growth. But I’m not sure how focused on the long-term people really are. For asset managers seeking to operate in the current environment and meet their fundraising targets for the next three years, technology first needs to solve the back office issues we’ve discussed.”
Stephen McConville: “Once the operational challenges have been unlocked, then we can really unleash the longer-term potential of technologies like tokenization, enabling fractionalised investments and increasing liquidity by facilitating a secondary market, all of which will be essential as private wealth participation becomes the norm.”
A quick wrap up
So, while regulators have paved the way with structures like ELTIF and LTAF, which our experts are all in favour of, the big blocker when it comes to ‘democratising’ private markets is operations and, by extension, technology.
Operations and resources are the key to unlocking distribution, and it’ll take efficient, standardised and scalable digital solutions to meet these challenges head on. Only then will we be able to make alternative investments accessible to all.