In search of higher returns and superior portfolio diversification, retail investors are actively seeking exposure to assets that have been off limits to them in the past. Regulators have traditionally been quick to articulate concerns over suitability, but democratization may prove to be unstoppable. The U.S. Securities and Exchange Commission (SEC) has already expanded its definition of accredited investors and discussed the removal of guidance that limits closed-end funds with large quantities of illiquid assets.4 Additionally, the U.S. Department of Labor has issued guidance that retirement plan advisors could make private equity investments available to individuals without violating their fiduciary duty.
There is widespread support within the industry for broader access to private securities, with almost 8 out of 10 asset managers surveyed saying that non-accredited individuals should be able to invest in private markets. Despite some hesitancy, nearly as many (72%) of LPs agree (Figure 1). Both groups are remarkably in sync, going so far as to agree on certain caveats to wider access. About one in five thinks exposures should be capped at a certain amount or percentage. A slightly smaller group takes a sterner view, suggesting that access should be limited to long-term holdings such as retirement plans. A majority, however, see no problem with retail access as long as fundamental issues such as valuation, transparency, and liquidity are worked out in advance.
Major industry names such as Carlyle Group, Hamilton Lane, and KKR have accepted the challenge and rolled out a number of ’40 Act funds focused on private markets. Some of these are tender-offer funds, which allow managers to limit the amount and timing of redemptions. Others, such as the Private Shares Fund (formerly known as the SharesPost 100 Fund) from Liberty Street Advisors, are interval funds that feature daily pricing and minimum investments as low as $2,500 from any individual, regardless of accreditation. Crossover mutual funds, while not common, aren’t new—as of 2018, they had already collected $48 billion of assets, according to iCapital.5
Because the working definition of “active management” is evolving to incorporate a wider range of securities and vehicles, this trend will almost certainly gain steam in the future. The promise of improved portfolio diversification has been a major driver of interest in private markets for retail advisors, particularly in the aftermath of the global financial crisis when so many markets crashed simultaneously. There is still a strong case to be made for diversification, as evidenced by the fact that only 1 in 10 survey participants say there is significant correlation between private and public markets (Figure 2).
The vast majority of industry insiders recognize at least some degree of benefit, but managers are more than twice as likely to claim that private markets provide an “excellent” source of diversification (Figure 2). Investors are more circumspect, with 38% saying the advantage may be less significant than commonly believed, thanks to infrequent pricing and low liquidity. Only 18% of managers voice similar concerns. Further democratization of private market investments will inevitably be accompanied by greater transparency, attribution, and performance analysis. The true value of diversifying portfolios with private markets will come into sharper focus as research accrues.Continue Reading
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