New regulatory policies continue to fuel market demand to make private-market assets more available to both ’40-Act funds and retail investors.
But even panelists at the SEC’s own conference on asset management couldn’t seem to agree on whether the crossover is a good thing, or how great either the risks or benefits might eventually be for retail investors.
There’s no question that investors in the US want easier access to high-performing private- and alternative-investment markets, according to Yana Morris, chief content officer at ION Analytics and moderator of the retail/private-markets panel at the SEC’s June 5 Emerging Trends in Asset Management conference.
Not every private-market segment can show performance worthy of the hype, however, or even enough to overcome negatives that include higher fees, lower levels of transparency and, often, less liquidity than retail investors are really looking for, according to panel member Ben Schiffrin, director of securities policy at Better Markets.
Many retail investors would be better off sticking with passively managed index funds rather than actively managed products, including private-market funds that could face lower rates of returns and liquidity problems in a volatile market, according to fellow panelist William Clayton, a professor in securities law at Brigham Young University.
That may have been true in the past, but individual investors are flocking toward private markets and demanding to be let in to a market they feel is unfairly closed to them, according to James Hannigan, managing director of Apollo Global Management.
“The public market is shrinking,” Hannigan said. “We need another avenue to deliver those superior returns.”
The number of public companies in the US is about 40% lower than it was 25 years ago, according to Mark Robillard, VP of alternative investments research at Fidelity Investments. Public investment markets are still healthy, and are still much larger than private, “but economic growth is increasingly happening in the private markets,” he said.
The number of companies going public has dropped in recent decades, Clayton said, but there is a circularity to arguments that the size of private markets and investors’ need for diversity are good reasons to allow retail access to private markets.
The number of public companies has dropped in recent decades, but some academic studies have shown that the number of companies going public had dropped as market regulation became more onerous and raising private capital got easier. Those changes reduced the number of public-equity options available, while causing private-market investments to grow.
“So one of the reasons we’re in this place is precisely because of repeated decisions that we’ve made along the way to relax the regulatory structure,” which makes more possible the kinds of problems that prompted Congress to pass the ’33 Act and ’40 Acts in the first place, Clayton said.
Even in the short term, it is concerning to see the industry pushing to be able to offer retail investors more opaque products with higher risk, and higher fees, Schiffrin said.
“There are quite a few challenges here, but also quite a few opportunities,” Schiffrin said. “We have to remind ourselves of the dichotomy that exists between the formation of capital on one hand, with private markets, and the protection of investors.”
“The literature is complex and takes some time to understand, but diving into it you can say there is a potential for enhanced returns in private markets over public,” Robillard said. “But it is a nuanced conversation [where it makes sense to ask] if we believe there’s merit to delivering access to private markets, to retail, how do you do it?”
Size and categorization
The asset-management industry holds a total of about $110trn under management worldwide, compared to markets for private or alternative investments, which account for between $20trn and $30trn, Robillard said. US investments account for about half of each of those markets; retail investors make up about two-thirds of the total. About 80% of that money is professionally managed, he said.
The largest private-market segment is private equity, but the category also includes real estate, infrastructure and natural resources, venture capital and private credit, which is among the fastest-growing, highest-profile segments of the market, Morris said.
The levels of performance, potential risks, costs and other considerations are also vastly different among those categories, she said.
Limiting risk
There can be more risk to private-market investments, but allowing investment managers at registered funds can mitigate that risk for retail investors, Robillard said.
There are tradeoffs in transparency, liquidity and higher fees, but “the degree of those trade-offs can vary by asset class,” Hannigan said.
Investment-grade credit offerings, for example, come with more disclosure and evaluations from independent credit rating, companies, for example, he said.
Retail investors who access private assets as shareholders in registered funds are protected by conflict-of-interest rules, disclosure requirements, fee limits and other safeguards they wouldn’t get if they invested directly in private companies or hedge funds, Hannigan said.
“If we step back and think about the trade-offs and potential benefits for people provided access [to private assets] through controlled environments like regulated funds,” Hannigan said. “The market has shown that there’s significant demand, with 60-billion plus raised in these regulated products year to date, and a growing expectation that the regulated product space will continue to grow.”
How that protected access should be allowed to happen will also be a problem, however, Clayton and Shiffrin agreed.
“If we’re going to allow retail investors – this huge market – to get into the private market space – it’s hard to think about how to make a private offering that sounds a lot like a public offering where you’re supposed to have disclosure, and that disclosure just doesn’t exist,” Schiffrin said. “The whole reason that the public markets have worked so well for retail investors is because there’s disclosure that protects these retail investors.”
“I also think the liquidity is a huge problem,” Schiffrin said. “I think retail investors are used to being able to get in and out of their assets quickly, and that’s just not the case in private market assets.”
Potential for strategic conflicts
Big changes at the SEC are driving many of the regulatory changes that will allow more private-market investments by ’40-Act funds. Still, those changes follow years of growing pressure whose motivations may have less to do with the interests of investors than the interests of the industry, Clayton suggested.
“It concerns me that this is happening at a moment when the private funds industry Is maturing, potentially facing the prospect of lower future returns, and is currently in the middle of a liquidity crunch” Clayton said. “It makes me somewhat uncomfortable to see an aggressive campaign for retail dollars when the industry is struggling to return capital to LPs, many of their LPs having sort of hit their max allocation and are cutting back on their allocation to private equity.”
Increasing private-asset investments could also tend to make the industry itself more important to retail investors, who have been told for years that the most efficient strategy is to focus on passive index funds and market growth rather than the skills of investment professionals.
“Investing in private markets kind of magnifies the importance of the role of the person sitting within that institutional investor so there’s more for them to do precisely because there’s no clear, standardized disclosure, there’s no clear market signal, market price signal, and there’s not a level playing field,” Clayton said.
“So more expertise and experience is needed than if the institution were just investing in registered products,” Clayton said. “Those inefficiencies and frictions allow you to charge more for your services.”
“Clearly it’s good for just about everybody in the ecosystem,” Clayton said. “It’s an open question whether it’s good for the retail investors themselves.”
Flexibility and customer choice
Private-asset access could provide far more productive and sophisticated investment options than most retail investors can currently access, by allowing them to pick and choose among a rapidly developing “alphabet soup” of wrappers satisfying differing requirements, Hannigan said.
Portfolios could include business development companies that require that at least 70% of a portfolio be invested in private companies, or in small-market-cap US companies, or REITs. They could also include interval funds and tender-offer funds with all the governance constraints, leverage and disclosure requirements and fee limits of a ’40-Act fund, he said.
“We can take comfort in the regulatory environment,” Hannigan said. “I think there’s a recognition that these products are not necessarily guaranteeing outcomes, but do offer a framework where there’s full disclosure and choice of the strategy; that does feel like a healthy system.”
“It’s not a complete portfolio solution, but for investors that have a bucket for medium-term savings, for example, can invest and capture some of the private market premium through these vehicles,” Hannigan said.
The market and the policies framing it are still developing, but “this discussion seems like a, you know, solution in search of a problem,” Schiffrin said.
“If the private markets are having a cash crunch, it’s not really up to retail investors to solve that,” he said.
“The public markets are supposed to be for everybody. That’s where retail investors get their protection. So that’s where all the opportunities should be,” Schiffrin said. “Instead, we’ve allowed these exemptions to proliferate to the point where it’s like, well, now all the good stuff is in the private market, so shouldn’t retail investors be there too?”
