Keynote interview: An appealing alternative
As private wealth investors increasingly turn their attention towards private markets, technology and regulation must develop at the same pace, says Tim Boole, Head of Product Management Private Equity at Schroders Capital, in an article originally published by PEI magazine.
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What would you say is the main driver behind private wealth investors’ growing interest in private markets?
Private wealth investors are looking to access the higher returns that private markets have historically provided. There is also a growing awareness that listed assets can be limited in terms of the exposure they give to the real economy. Furthermore, a lot of investors had a pretty tough time with their public markets and fixed income portfolios in 2022, and therefore in 2023 began looking more closely at alternatives that offer strong returns but with lower volatility, thereby better fulfilling their long-term objectives.
Meanwhile, on the supply side, advancements in technology are enabling investors to access private markets in ways that would not have previously been possible — for example, the rise of digital fundraising platforms. Regulatory changes have also supported this shift, while product innovation means there are funds available that are better suited to private investors’ unique needs.
Given the challenges private markets firms are facing when it comes to raising capital from traditional institutional investors, has accessing private wealth investors become more of a priority?
Global private wealth represents a massive potential client base for private markets firms on account of its relatively low allocation to private markets at present. It is therefore one of the most important client segments for investment managers to serve. In parallel, the pace of new investment from many of private markets’ traditional client groups – such as pension funds and insurance companies – has slowed. In some cases, this is due to the denominator effect, where private market allocations in a portfolio have reached their limit.
In others, there are structural factors, such as defined benefit pension schemes either being de-risked or in the process of de-risking. In contrast, the private wealth investment segment is growing fast from a low base. In response, many large private markets asset managers have been committing significant resources to tapping this pool of capital. They have set up dedicated teams focused on wealth management and are also forging partnerships with traditional infrastructure providers, such as mutual fund platforms. Building up those relationships is really important because often these platforms act as gatekeepers to the private banks and wealth managers that ultimately control or influence private wealth capital.
We are also seeing funds being launched that focus exclusively on private wealth. These funds have characteristics designed specifically to appeal to that investor base, including single capital calls versus multiple capital calls, semi-liquid structures that offer greater flexibility, and regulated fund structures that can be distributed to non-professional investors.
What challenges continue to hold back the growth of private wealth investment?
Quite a few challenges remain. Certainly, anyone who thinks they can take a traditional private equity fund and just start pitching it to private wealth clients without considering the specific needs and preferences of those clients may encounter challenges in achieving success.
Many wealth managers and private banks are still not fully operationally adapted to providing access to private markets, especially in the classic sense where an investor makes a commitment and then receives capital calls over time. Those operational considerations are holding back quite a bit of growth. Having said that, wealth managers and private banks increasingly recognise that this is something they need to overcome, because they realise that investor interest in private markets is not a temporary phenomenon. It is a long-term shift, and they are investing in systems to support access to private markets as a result. For now, however, this remains an important barrier to selling private assets to this client base.
The regulatory environment is still also quite restricted. In some markets, there are real limitations in terms of which clients can be marketed to and what can be pitched. In addition, we are currently experiencing significant economic and political uncertainty. High interest rates have made investors cautious about moving into more illiquid assets: when someone can achieve a 6 percent return on cash, that is compelling, and some are therefore deciding to hold off entry into private markets while they wait and see how the macroeconomic backdrop develops.
What is your own approach to the democratisation of private markets as a firm, and how are you seeking to build your business in this area?
Our priority is to be seen as a partner for wealth managers and private banks. That means ensuring there isn’t only a single entry point for private wealth investment into private markets. We are not just going to launch a set of private markets funds and then sit back and let investors choose. There need to be multiple entry points depending on the type of investor you are selling to and the asset class you are fundraising for.
Many value the opportunity to choose from a range of ready-made, off-the-shelf options, and semi-liquid funds have played an important role in meeting that demand. But we also see demand for bespoke, white-label strategies. In that scenario, we are able to do all the heavy lifting behind the scenes to facilitate access to private markets, carrying out all the structuring and supporting the investment selection. This way, the asset manager or private bank only needs to think about how to incorporate private markets into portfolios and sell that opportunity to their end clients.
How do you expect the regulatory narrative to evolve in 2024, particularly as it pertains to European Long- Term Investment Fund 2.0?
There are still aspects of uncertainty that remain when it comes to ELTIF 2.0. Certainly, there have been improvements in terms of what ELTIFs can and can’t invest in. The ability to invest in funds, as opposed to only making direct investments into assets, is to be welcomed, particularly as fund investments offer greater levels of diversification. Trying to build up a diversified portfolio of direct investments requires a larger fund size, which therefore acts as a barrier to entry for new managers.
There have also been improvements when it comes to investor eligibility. For example, it will become easier for wealth managers and private banks to offer ELTIFs to their client base without the complex eligibility checks that had to be carried out in the past.
However, a lot of uncertainty still remains around liquidity mechanisms; that uncertainty has dragged on for longer than many expected. The initial expectation was that from mid-January, everything about ELTIF 2.0 would be out in the open and we would immediately see a proliferation of new funds being launched. That is looking unlikely: at the time of writing, we are awaiting more clarity given the question marks that remain in terms of what is permissible from a redemption and liquidity perspective.
We continue to work closely with industry bodies, providing guidance as these matters are worked through. What we don’t want, of course, is to end up with a set of rules that strangle growth before it has even started. We need to work towards a situation where there is a healthy level of choice of ELTIFs available for the private wealth market, which means reducing barriers to entry.
How far do you believe this democratisation process will go?
There is absolutely no question that private wealth is going to play a very significant role in private markets going forward. The level of demand that we are seeing is high – not only in Europe, but in Asia and the US as well. That said, there is still a degree of hesitation. Private banks and wealth managers are displaying some caution around whether they are operationally capable of meeting that demand.
Education is therefore vital – and not only education of the end clients, but of the relationship managers that are working with those clients, so they really understand what it is that they are selling and whether or not it is appropriate for a given individual.
Technology is also going to play a major role. In particular, we are seeing a lot of interest in tokenisation. This is something that Schroders is spending a great deal of time on. We have a team working on multiple pilot projects in different geographies to see how tokenisation can be used to unlock private wealth investment – not only in private markets, but in listed markets as well.
In the context of private markets, tokenisation could potentially introduce greater flexibility and liquidity while also taking away some of the frictional costs of what can often be a cumbersome subscription process. Overcoming a lack of familiarity with private assets and then embracing the benefits that technology can offer could drive a lot of change.
Finally, there is also a school of thought that there will be an increased blurring of the lines between listed and private markets as the technology develops. We are already seeing that with fixed income, but the expectation is that the distinction between listed equities and more traditional private equity will begin to fade as liquidity restrictions ease and tokenisation allows for a greater level of trading.
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