This article is sponsored by IDR.
What is driving appetite for private markets among private wealth investors?
Mark Quigley: High volatility and poor performance in the public markets have increased awareness of the benefits that private markets investment can bring. Research by Harris et al, published in The Journal of Finance, noted buyout fund performance consistently out-performed that of the public markets, for example, by 20-27 percent as compared to the S&P 500 over the lifetime of the fund.
There are also challenges, of course, including regulatory hurdles. In the US you must prove you are an accredited investor, for example, although we have seen more recognition from the Securities and Exchange Commission recently that it is desirable to expand the access of retail investors to the private markets. There are also liquidity challenges given that capital is locked in for longer in private markets. But, overall, private wealth investors increasingly appreciate the advantages of private markets investment, and regulators are looking at ways to facilitate greater access.
How are managers responding in terms of more private wealth friendly products?
MQ: We are seeing a number of developments including the use of 506(c) funds that can publicly advertise rather than just going through wire houses. There are also tech platforms with a fund of funds model, allowing private wealth investors to go into a feeder vehicle that then invests in the underlying funds. Additionally, some managers are looking to employ smarter technology to get their funds out to a greater number of wire houses, rather than the handful they are engaging with currently. There are some interesting tech start-ups in that space backed by managers who are seeking to deliver private markets investment opportunities to a wider investor base.
What challenges persist around onboarding?
Tim Andrews: The onboarding process in private markets is not fit for purpose and never has been. Go back to the 1980s, and we were probably filling in pieces of paper. The industry then moved on to PDFs and that is where the evolution of private markets has stuck. That might be adequate if you have 30 institutional investors in a fund that have accepted an elongated application process as part of the price of doing business. Those investors will have extensive legal departments to negotiate terms. But the largest funds being raised today have perhaps 200 institutional investors, as well as 800 individuals. At that point, it doesn’t matter how good your PDF is, it is still a PDF and that is creating a number of challenges.
First, in a time of legislation like the General Data Protection Regulation and California’s new privacy law, investors are concerned about the security of the information they provide and the fact that as soon as they provide it, it leaves their control. Second, they are frustrated by the repetitive nature of providing substantially the same information, often to different representatives of the same fund manager.
Third, the additional requirements of qualifying individuals as accredited investors inevitably means more questions need to be asked and investors need support in answering these. The private markets investment process as it exists today is simply not equipped to deal with these changes in the volume and composition of its investor base.
The consequences of not resolving these challenges should not be underestimated. If you cannot get investors into your funds without significant cost, resource and risk, it becomes an existential problem. If your competitor has a superior process and that prevents you from getting the lifeblood into your fund, then it’s game over.
To what extent can technology resolve these issues and to what extent is it necessary to retain the human touch?
MQ: As well as causing frustrations for investors, the onboarding process involves huge effort on the manager side. As private markets continue to democratise, a higher volume of investors will only exacerbate these problems. More investor relations resources will be required, and the headache of trying to align the review of legal documentation, know your customer documentation and tax documentation – sometimes carried out internally and sometimes externally, in multiple different locations, before being keyed into a customer relationship management system – will only get worse.
We believe technology can help solve the initial hurdle of getting all an investor’s information in one location. We also believe that a managed service component is crucial to making this work in practice. You need a team of professionals on hand to help investors along the journey.
TA: When we look around the market, we see service-orientated suppliers such as law firms, with lots of clever people, and we see tech platforms that believe every problem in the universe can be solved through the efficient use of technology. Perhaps it can be, but at the end of the day, investors are humans, and they appreciate human interaction. It surprises me how few organisations have emerged in the private markets ecosystem that blend technology with an intelligent, human service.
As private markets democratisation evolves, what is the ultimate solution to these residual challenges?
MQ: As larger volumes of investors seek access to private markets, fund managers will need a solution that is fit for purpose. They need the information they collect to exist in one place and they need to be able to re-use that information on an ongoing basis, so that once an investor has cleared the hurdle to invest in private markets, they never have to go through that pain again. We believe technology combined with an intelligent and caring managed service is what is required to support that greater volume of investors coming into these asset classes.
TA: In the public markets, you can buy a handful of shares in a major listed corporate via an app on your phone. Private markets are never going to be quite like that and nor should they be. There is a higher investor hurdle because you are locking up your capital for longer. But I think the democratisation of private markets and the opportunity it is creating for fund managers to attract private wealth investors into the space will do two things.
First, it will increase the requirement for distribution through technology, including the onboarding process. Second, it will act as a force for centralisation. The idea of a central exchange has been in the public markets for a long time but still doesn’t exist in private markets today. I think that is where we are ultimately heading.
Any exchange will obviously be tech dependent. But to access the exchange you will need to be authenticated, a process that is typically carried out by a broker. We see ourselves, fundamentally, as providing authentication, and in the future, perhaps also settlement services, for private markets.
Tim Andrews is founder of investor onboarding hub IDR and Mark Quigley is subscription service lead at the firm