Defined benefit pension schemes have, historically, been mainstay institutional investors in alternative funds. But these schemes are winding down as members pass on and their liabilities disappear. So their investments in alternative funds, including private capital, are also diminishing. If private capital managers are losing investors, how can they attract new ones?
The decline of defined benefit schemes is widely documented: In the UK, for example, the number of schemes fell from 7,751 in 2006 to 5,327 in 2020, while the number of scheme members dropped from 14 million to 9.9 million over the same period, according to The Purple Book. This phenomenon is being mirrored elsewhere in the developed world.
The retail market offers a potential option, but what issues would this raise around marketing to investors who regulators regard as less sophisticated?
Regulations and liquidity present challenges
There are several challenges to be overcome before retail investors can invest at scale in private capital.
First, regulatory changes must be introduced. Such regulations have yet to be outlined in the EU – although there have been some developments in the US – but transparency will undoubtedly be a key requirement when they are. Retail mutual funds must currently publish substantial reports giving details of products and investments, and if general partners are to raise interest then they will have to meet the same standards of disclosure. Furthermore, these disclosures will have to be delivered via automation platforms, whether by intermediary fund platforms or the GPs themselves.
A second major issue is liquidity. Daily dealing is standard in the retail world but that is not so among private funds, which would have to address how they would structure their liquidity. This will be important because many retail investors will be deterred by low liquidity despite higher returns being available. For example, some retail UK real estate funds incurred some damaging PR when they had to suspend dealing during the covid-19 pandemic.
Assuaging investors’ fears
GPs will have to address investors’ understandable trepidations if they are to draw interest.
As well as providing greater disclosure around funds, investors must be educated about the pros and cons of private capital investments.
GPs will also need to work with policymakers to ensure the right regulations are introduced to allow retail investors to invest in the right ways and to ensure they understand the concepts involved. For example, it is important that investors understand they have the potential to secure higher returns if they sacrifice liquidity.
The liquidity issue can also be addressed by structuring solutions that include financing and loans to alleviate the problem without sacrificing returns or by charging higher fees for less liquid asset classes. Another possible solution is with innovative fund structures such as a listed PC investment trust.
Certain asset classes will also appeal more to retail investors and attract them to private capital, such as renewable energy and other sustainable investments like forestry, and venture capital will be a focus for investors.
Retail investors represent a different audience than that which GPs are familiar with, so the show must be different too.
A pension scheme is one client investing perhaps $100 million, but with the retail market, hundreds or even thousands of investors must be serviced for the same AUM, which is a much harder exercise. Know Your Customer and anti-money-laundering checks become much more complicated, for example. Disclosure too: in Europe, GPs would have to prepare something similar to a Packaged Retail and Insurance-based Investment Products (PRIIPs) document, which would be a new experience for them.
Outsourcing could be more cost-effective
All of the above will require significant extra spend on new expertise, staff and technology.
It may be that larger GPs will expand their in-house resources, but private funds are generally lean operations that are best focused on raising and deploying capital. They will have to decide whether it is more cost effective to outsource the required functionality to specialist service providers that can offer economies of scale, as well as leading edge technology and the latest industry best practices – all of which are more relevant in the retail market because of the greater numbers of investors and data volumes involved.
First mover advantage
There are already moves towards opening private capital to retail investors. These are most advanced in the United States, where guidance has been issued on allowing 401(k) pension holders to invest in the asset class and laws are going through to allow private equity fund managers to sell to certain types of retail investors.
In the European Union, it will probably be three to five years before the required regulatory changes are enacted, while the UK is even further behind, although there is some lobbying taking place.
Larger GPs may have the resources to market themselves to these new retail audiences when they emerge, while others may find it more effective to be listed on fund platforms.
Either way, there will be a major advantage in preparing for what lies ahead and being among the first movers when regulatory changes mean retail markets do indeed become available to GPs.
Edwin Chan is senior director, head of funds business development, UK at corporate management firm Intertrust Group.