This article is sponsored by Apex Group
Increasing the participation of retail investors in the private equity asset class was a hot topic as we entered 2020. Coronavirus may have disrupted the momentum, but there are longer-term questions to be asked about retail investors’ access to private markets. We talked through the challenges and opportunities involved in opening up private markets with global financial services provider Apex Group’s Elaine Chim, head of private equity and real estate, Americas, Gareth Smith, head of private equity and real estate, EMEA, and Rajeesh Khanna Chinnaswamy, head of private equity and real estate, Asia-Pacific.
Allowing retail investors to access private markets was hugely topical pre-covid-19. What trends did you see in each of your regions before the crisis?
Elaine Chim: This concept has been out there for discussion for a while, certainly in the US. It is obvious that retail investors have been looking for ways to outperform the public markets, but the opportunity hasn’t been there. There is well documented evidence that private equity as an asset class does consistently outperform, but retail investors were missing out for a whole host of reasons, only being able to access the asset class indirectly.
This was very topical here at the end of last year because the Securities and Exchange Commission published a piece in November calling for more investment opportunities in private markets for retail investors. There were questions raised around changing the rules that govern the way private equity funds raise capital and trying to engage the public for comment. The concept is not new, but the SEC has sought to push that agenda forward a little. The paper points out that as of April 2018 there were 103 privately held US start-ups with valuations of over $1 billion and a total value of $385 billion; less access to private companies means retail investors are missing out on the opportunity for excess or uncorrelated returns.
Gareth Smith: Classic private equity products have never been a natural fit for retail investors, so even before covid-19 there was a high price point for entry. That meant private equity was purely the preserve of sophisticated institutional investors. Those retail investors that do want to access it would tend to go in via the big asset managers that have their own listed funds.
Rajeesh Khanna Chinnaswamy: In Asia-Pacific, private equity has delivered higher returns and lower volatility than public markets over the past two decades, and retail investors remain under allocated to this alternative asset class. We can see a trend among retail investors to try to get access to private markets but, due to regulatory constraints, retail investors are not allowed to access private markets directly due to higher risk appetite.
There are different, indirect ways that Asian investors are trying to subscribe into private equity investment. This includes preferred access structure, which allows retail investors to invest into private equity in a responsible and prudent manner. Investors are exposed to the same upside potential and downside risk that comes with private equity investing. Another example is listed investment companies; the common but indirect way for retail investors to access the private equity market is to subscribe into shares or bonds of a listed investment company which holds the private equity investments.
What restrictions prevent retail investors gaining access to this asset class?
EC: The SEC paper talks at some length in favour of regulatory changes that would help expand retail investor access to private markets. One of the key areas is eliminating the accredited investor threshold for offering regulated funds of private funds, which requires that registered closed-end funds that invest more than 15 percent of their assets in private funds must be limited to accredited investors. There needs to be more flexibility around that. Another suggestion is expanding the definition of accredited investors.
In addition, questions arise around how retail investors would compete with the more sophisticated institutional investors, like pension funds, who are better placed to negotiate favourable terms for management fees and carry rates. For retail investors, management fees are expensive and could be a barrier to entry. Structurally, fund managers need to be thoughtful about how retail investors might come through, say, via a feeder type vehicle with their own terms for management fees and carry so that they are segregated from the rest of the investor base.
GS: The entry ticket is the major stumbling block. It’s a long commitment – retail investors cannot get money out when they need it. From a regulatory perspective, the subscription levels are often set quite high in order that the regulation around the funds only encourage sophisticated investors in. In return the funds often benefit from a “lighter touch” regulatory regime applied. Investors sign up to certain representations and warranties to ensure this. However, the biggest restriction preventing retail investor access is just the overall nature of the asset class.
RKC: The real barriers in our region are regulatory restrictions, to safeguard retail investors from private equity investments which are high risk and not suitable for these types of investors. Other points to consider are the long-term commitments in the fund during which it is not easy to get money out. Retail investors are more suited to real estate funds that generate a stream of income and capital on a monthly or quarterly basis. Private equity is a more high-risk investment and is not generally suited to the risk appetite of retail investors in Asia.
What impact do you think covid-19 will have on the private equity industry generally?
EC: Fundraising is definitely going to be impacted. Some of our GP clients are telling us that they are pushing on full steam ahead to close funds that are already in process and they want to stay focused on locking in commitments that were already under discussion. Others are postponing fundraising efforts because certain investors have decided to take a pause on their investment activity. Depending on the investor base and the reputation of the fund manager, fundraising will be impacted in different ways. The more experienced fund managers are probably going to be less impacted than those raising first-time funds. We are also seeing market opportunities come through because of the liquid and private credit market dislocations and there has been a noticeable uptick in opportunistic credit strategies emerging and I think this will continue in the coming months or years as the market adjusts. I also expect to see a shift in fund manager investment strategies to be more ESG focused as this global crisis has highlighted how critical it is to prioritise societal and environmental issues.
GS: We are in a difficult time but there are opportunities as well. The private equity industry has proven itself to be very adaptable and resilient, though there will inevitably be casualties, particularly among those investors that have focused on certain sectors like retail and hospitality.
Private equity has an important role to play in deploying capital and those with dry powder ready to invest will be in a good position to access deals and drive activity around the recovery. The industry will have a key strategic role in rebuilding the economy through rapid, targeted capital deployment. I expect we will see a key vintage of funds resulting out of covid-19, which will be strong, sector-specific and forward looking.
RKC: From an Asia-Pacific perspective, all private equity activity has slowed down, and we have seen people shelving fundraisings. Funds are not able to make investments and, of course, there is a financial impact on underlying portfolio companies that has an impact on the funds as well.
Due to unstable markets and challenges to determine the fair market value of portfolio companies, there’s a delay on investment due to longer due diligence processes and valuations of underlying portfolio companies. Also, we can see difficulty on operations, a decrease in investor confidence and investors not having enough information to make good decisions.
Do you think this crisis will impact retail investors’ ability to access private markets?
EC: Private equity is an illiquid asset class. Right now, some investors cannot afford to invest particularly if the public markets are not performing. I think there is going to be a pause until things stabilise. The industry will bounce back, investor appetite will follow suit and there will be a shift in focus back to these areas when the time comes and the markets are ready.
GS: I don’t see the position becoming any easier for retail investors in Europe. The issues that existed pre-covid-19 have not been mitigated at all by the pandemic and liquidity will continue to be a major factor for investors who will not necessarily find a more open door to private equity. The supply side will be key, where retail investors continue to favour deep markets that are highly liquid and protect them, while private equity funds want to raise capital based on how quickly they can mobilise. If we were to see easier access for retail investors, I imagine the US would move forward on that before Europe.
RKC: Certainly, this crisis will have an impact on the ability of retail investors to invest in private market as this is not the right time for retail investors to go into private markets. In Singapore, for example, regulators are more focused on making sure that retail investors are not getting into high risk investments and that shows no sign of changing, just as investors remain averse to making the necessary long-term commitments of capital. It’s a long-term commitment and due to market instability, retail investors will stay away from private equity investment until things settle down and the economy is back to normal.