How democratisation is revolutionising private assets

Private markets continue to evolve, and as they do, the investor base continues to broaden. Interest from two new investor types in particular is rising fast.

• High-net-worth investors
• Affluent investors

For high-net-worth investors, we expect each investment or “ticket” to be approximately £100,000 to £200,000. Affluent investors will likely invest around £10,000. Then, of course, there are defined contribution pension funds increasingly becoming active.

This shift has been happening over several years. Every year we see more capital coming in from those new sources, while traditional institutional investor flows are staying pretty much stable.

Is this “democratisation” changing the nature of private assets themselves?

Private assets’ complexity – and what has changed for individual investors

Regulators have given considerable thought to the issue of private asset complexity for retail clients.

The Alternative Investment Fund Managers Directive was launched several years ago seeking to eradicate, among other things, the so-called “grey capital” market. This is the unregulated end of the private client capital market, often related to private assets.

The industry now is far more regulated. Managers are regulated, and new fund structures have been created that are subject to much more rigorous control. This includes criteria like minimum diversification or maximum foreign currency exposure. It also covers the way products are sold and explained to clients, as well as gauging how clients qualify, or demonstrate their understanding of what they are investing in. All of it is welcome.

At the same time, public markets are shrinking and private markets continuing to grow. Regulators are keen to enable private client access to a significantly growing part of capital markets, so as not to exclude attractive return sources. It remains vital of course, that this progress is balanced with safety for the investors.

The balance has led to new formats such as long-term asset funds (LTAF), in the UK, and European long-term investment funds (ELTIF). Similar formats are emerging in other countries to make it possible for clients to invest in asset classes like private equity. These formats offer investors a different route of access into private markets, complementing the investment trust landscape that has existed for many years.

Schroders has received regulatory approval from the UK’s Financial Conduct Authority to launch the first Long-Term Asset Fund (LTAF).

LTAF in a nutshell

LTAFs offer long-term investors access to a wide range of assets, including private market investments, which have until now been available only to a minority of investors. The LTAF will offer new investment opportunities and choice to a bigger group. The wider economy will benefit as LTAFs should also bring fresh capital into important new projects such as infrastructure.

Why are LTAFs being introduced?

The UK government has been supporting greater investment in private market assets for some time, but the project was given specific support in November 2020 when the Chancellor of the Exchequer committed to the launch of LTAFs. The goal is to foster long-term economic growth and drive more capital into unlisted UK companies and infrastructure. At the same time, it broadens options for investors looking to build their retirement pots. It replicates a similar initiative in the EU, where European long-term investment funds (ELTIFs) are being developed.

How will an LTAF work?

The LTAF will be an “open ended” fund, meaning it can grow to accommodate new investor demand by issuing new “shares”. It will also enable investors to withdraw their money, by cancelling shares, according to agreed rules. The shares in the fund will reflect the value of the fund’s holdings.

The fund’s liquidity – the ability to raise ready money in order to meet investors’ potential withdrawals – will be carefully managed. Investors will be able to buy into, or sell out of, the fund, at longer intervals than traditional open ended funds which deal daily. A portion of an LTAF’s assets may, for example, be in listed assets which can be sold more quickly and where a price is more readily available. The rest may be private assets which take longer to sell, or liquidate. The mix and nature of the assets will determine how often investors will be able to buy or sell the fund.

Mirroring this, there are rules to govern the frequency with which the fund’s investments, including private assets, are valued.

Filling the knowledge gap

Where we believe more progress is needed now is in investor education. As asset managers it’s a big task for us, and an even bigger for the wholesale distributors – such as private banks – to make sure investors receive the explanations they need.

It is important that clients are fully informed and are clear on the extent to which they can bear the illiquidity of investing in private markets.

That works more easily in certain parts of a private client’s asset allocation – in personal pension savings, for example. People need to understand that using private markets in pursuit of higher returns comes with the price of sacrificing some liquidity.

The investable universe is getting bigger

Once new fund structures have started to proliferate, more investors will be investing into private markets, likely augmented by the addressing of “systematic” under-allocations; the allocations they could have had if it were not historically difficult.

At the same time though, the investable universe will continue to grow. Private markets have been limited to private equity and real estate for much of their history. Over the past 15 years, there has also been greater use of private debt and infrastructure.

The next markets to grow and mature may be natural capital and various digital assets. As digitised or tokenised assets grow in importance, many more assets will become set up ‘on chain’.

A consequence of this would be the industry increasingly overcoming the “bite size” problem; making investing by smaller increments easier. The costs of transferring assets from A to B would also decrease.

Right now, deals are very chunky, and it is very expensive to buy and sell a private asset. If you imagine that trading becomes frictionless and more “fractionalised”, the combination of both trends – democratisation and digitisation – is very interesting. Over a five-to-10-year horizon, we could see as much as a doubling, or more, of private markets.

What do private clients expect?

Anecdotally, private clients are often seeking returns hovering around the 8-15% mark. Secure liability matching income of around 4-5% – what institutions need – is not really what a private client is looking for. Very high risk strategies are sometimes sought-after, but they are not what we think should be offered to a broader market.

In our own product offering the share of secondaries and co-investments – rather than private equity fund investments – is higher. The reason for this is quicker deployment, and shorter duration. This means liquidity being deployed more quickly into investments, and coming back more quickly, if needed.

Some investments are happening within semi-liquid funds, which have a degree of liquidity built in. You want the client to see their capital get invested fairly quickly. Institutional investors can endure long J-curves. This describes the return profile of institutional capital being invested over time, to then create a portfolio that generates returns further down the track.

Schroders is already a market leader in offering structures which provide greater access to private assets through its range of listed vehicles, as well as semi-liquid and illiquid structures. Following regulatory approval to launch an LTAF in the UK, Schroders Capital – the private assets division of Schroders – will focus on providing eligible investors with the opportunity to access the breadth of our private asset investment capabilities.

This article was originally published in Citywire: Alternatives in Focus on 21st March 2023