Private wealth investing in private markets: all you need to know
The demand for private assets continues to increase, not only among traditional institutional investors. We examine how private markets are rapidly evolving to better serve individual investors.
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In the past, private assets - like private equity - were accessible only to large institutional investors. But that’s changing.
One of the main reasons private asset investments have been out of reach for private investors until recently is the nature of transactions. It can be very time consuming to source deals and complex to structure them, while exits can also take a long time and pose their own difficulties.
However, demand from private investors has been growing. Many of the large private asset managers that previously catered only to an institutional client base are developing more accessible products.
So, what has led to this change? What does it mean for the industry? And what does it mean for smaller, private investors?
Here we explain the product, technology and regulatory developments that are opening the doors of private asset investment, and the additional challenges which persist.
Demand heating up, supply is responding
The chart below shows a demand “heat map” for private assets over the next 12-24 months amongst European private banks and wealth managers. The data demonstrates strong anticipated growth among family offices, ultra high-net-worth investors (UHNW) and high-net-worth investors (HNW), often from a low base.
In parallel, new investment from many of private markets’ traditional institutional client groups – such as pension funds and insurance companies – have slowed. In some cases, this is due to the denominator effect, which occurs when a part of the portfolio, typically public market allocations, decreases in value through market volatility, and reduces the overall total value of the portfolio. As a result, segments of the portfolio that did not decrease in value now comprise a larger percentage of the total. This commonly affects investors in private markets who can find themselves overallocated to private markets.
In other cases, there are structural factors such as defined benefit pension schemes, which have either de-risked or were in the process of de-risking.
In response to these changing client dynamics, many large private market asset managers have been committing significant resources into tapping this pool of capital. Responses vary from setting up dedicated teams focusing on wealth management to forging partnerships with traditional mutual fund managers who act as gatekeepers to traditional private banks or wealth managers. Building relationships with intermediaries is key as they control or influence flows from private wealth investors.
Whilst considering the demand, it is important to note that the underlying asset classes haven’t changed. An infrastructure loan can have a life of 30 years, and a private equity owned company a typical ownership period of 5-8 years.
However, regulation around who can hold private assets has started to loosen, while technology is simultaneously breaking down the barriers of illiquidity, allowing more access to new innovative fund structures.
How have products evolved?
Several private markets managers are launching funds that exclusively focus on private wealth. These funds have characteristics 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.
These fund structures can be grouped in two buckets: open-ended or closed-ended. These can be split into three degrees of liquidity; liquid, semi-liquid or illiquid.
Semi-liquid open-ended funds
Innovation in open-ended semi-liquid funds, especially for asset classes such as private equity, private credit, and real estate, has been progressing rapidly. These feature monthly or quarterly subscription and redemptions cycles. Liquidity comes from two sources:
Investor subscriptions and redemptions
Investment distributions
Subscriptions and redemptions are at the fund’s net asset value (NAV). This removes the volatility or market beta compared to closed-ended funds, which rely on a secondary market for liquidity.
The liquidity management in a semi-liquid funds is achieved through portfolio construction and liquidity management tools. Portfolio construction provides the first line of defense. A well-constructed portfolio, one that is diverse by geography, sector, type, and vintage, can engineer a level of “natural liquidity” that is regular and consistent. When we ran various simulations across our private equity investment programmes, we found that in all but the more extreme market situations, the level of natural liquidity was more than sufficient.
As a second line of defense, semi-liquid funds often use tools such as redemption caps or the possibility to suspend subscriptions and redemptions so the manager can better control liquidity within the fund. An associated objective is that by using these liquidity tools, it helps to moderate investor behaviour in the event of market stress events. If an investor knows they would have to wait three to six months before they can exit a fund, they are less likely to exit impulsively.
Liquidity management also needs to be considered in terms of cash subscriptions to the fund, as cash balances can lead to a performance drag.
Closed-ended listed funds
Whilst semi-liquid funds have improved access for investors, there are investment strategies that are still best accessed via closed-ended funds. There has also been a high level of innovation in this space.
Closed-ended listed funds could offer private investors an ideal means of accessing a private portfolio while retaining the flexibility of daily dealing.
One of the fastest areas of growth has been the launch of closed-ended funds with no liquidity or periodic liquidity windows. There have been some new web-based platform launches in recent years that offer private investors access to a wide variety of private asset strategies through feeder funds. Technology has helped bring down a lot of the upfront and costs and complexity in offering these feeder funds to new investors.
Regulatory changes have also opened up more opportunities for new fund launches (more of this further down in the article). These new closed ended fund structures are designed specifically for private investors, by having a structured capital call schedule, a shorter fund term than more institutional orientated funds and lower minimum subscriptions amounts.
How is technology helping?
One of the key technological developments in making private assets more accessible is platforms that allow entrepreneurs to raise equity from seed investors while previously confined to friends and family. Internet based platforms include Seedrs (UK), SeedInvest (US) and investiere.ch (Switzerland). Entrepreneurs can pitch their ideas and start-ups to private investors who can choose the amount to invest, even with small amounts such as $500. Similar concepts apply in real estate.
The concept has also extended to private credit, traditionally the exclusive domain of banks and specialist lenders. In private credit, a notable development has been peer-to-peer lending. Private investors can choose to provide loans to individuals or companies for higher returns than would be available through traditional savings accounts or fixed income securities.
Other ways technology has opened up access to private assets is via new distribution and communication channels. Registration of new investors is automated, reducing the time and cost of onboarding new investors, that previously relied upon a branch network or paper-based process. Similarly reporting can be digitised, which helps reduce the cost for investment managers to make it more economical for small subscription amounts.
We are excited by the prospect of further innovation that will help further support the opening up of private assets. This includes the prospect of “tokenisation”, which 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. By being able to provide investors with a digital right of ownership over an asset using blockchain technology, the cost to the investor for having a share in the ownership of an asset reduces significantly.
Regulation shifting to facilitate private asset access
Regulation still poses challenges to the opening up of private assets and our experience is that changes in regulation have been uneven between markets.
However, many governments recognise the growing role of privately sourced capital as important for economic growth and job creation. As individual investors provide an important source of capital to an economy, there is growing emphasis on updating regulatory frameworks to facilitate their access to the market.
Examples of new regulation can be seen in several jurisdictions. In the UK, the most recent development has been the Long-Term Asset Fund (“LTAF “), which enables investment in long-term, illiquid assets whilst offering the structural safeguards associated with a regulated fund. Recent updates have also expanded its distribution scope, allowing LTAFs to be sold to eligible retail investors, and be included in certain types of Individual Savings Accounts (“ISAs”), a popular tax efficient investment vehicle.
Elsewhere in Europe, the European Long Term Investment Fund (“ELTIF”) regulation has been rebooted and called ‘ELTIF 2.0’ by the market. The updated regulation offers several enhancements to the original structure: a broader scope of eligible assets and investments; simpler investor eligibility requirements; potential for ELTIF master-feeder and fund-of-fund structures; and greater liquidity.
The original regulation only allowed closed-ended funds, but the new rules introduce the possibility of redemptions before the end of a fund’s fixed term life. The precise rules for redemptions are still under discussion between market participants and the regulator but expected to be finalised over the course of 2024.
Further afield, the US Department of Labor has ruled that 401K plans could invest in private equity, and demand amongst individual investors has grown strongly with the increasing number of semi-liquid funds available.
Whilst these are all welcome developments, sometimes the regulatory guidelines have lagged the pace of technology and innovation. It is a delicate balance that regulators must navigate to extend access, while ensuring that their primary role of protecting investors is maintained.
What other challenges continue to hold back the growth of private wealth investment?
A common obstacle to accessing these markets has often been operational or technical difficulties. Many wealth managers and private banks are still adapting their back office systems to access private markets, especially in the classic sense where an investor makes a commitment and then receives capital calls over time.
However, they recognise that this is a challenge they need to overcome, given that investors’ interest in private markets is here to stay. As a result, more investment is going into building technical infrastructure.
Another challenge for investors is market sentiment. With significant economic and political uncertainty, a new rate environment and high inflation, investors are more cautious about investing in illiquid assets. Coupled with the compelling story of cash returning up to six per cent, some investors have delayed their allocation to private markets .
What future developments?
Increasing allocation to private markets from private wealth clients looks certain. Whether the pace stays the same will be determined by macro factors and the changing regulatory environment.
We believe that access and liquidity will continue to evolve and support further opening up. This also leads to a situation where the distinction between private assets and listed securities becomes less pronounced and the ownership status less of a factor in the investment strategy. We are already seeing that with fixed income, but the expectation is that the distinction between listed securities and private markets is expected to fade as liquidity restrictions ease and tokenisation allows for a greater level of trading.
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