This article is sponsored by Schroders Capital.
How is the private markets investor base changing?
We are increasingly seeing two new forms of investors coming in: high-net-worth investors and affluent investors. High-net-worth investors will probably invest approximately €100,000 to €200,000 per ticket, whereas affluent investors will invest around €10,000. Then, of course, there are defined contribution pension funds increasingly becoming active.
This shift is not happening overnight, it is one that has been happening over the course of several years. Every year we see more capital coming in from those new sources, and pretty much stable allocations in the traditional institutional investor groups.
Private equity has been considered too complex for the man on the street to invest into. Is this outdated?
Regulators have thought about this quite a bit. The Alternative Investment Fund Managers Directive was launched several years ago to essentially eradicate, among other things, the so-called grey capital market, which is the unregulated end of the private client capital market, often related to private assets. Of course, now a lot more regulation has come in for the industry. Managers are regulated, and new fund structures have been created that have much more rigorous characteristics. This includes criteria around minimum diversification, maximum foreign currency exposure, and the way products are sold and explained to clients, as well as what the qualifications are of clients in the sense of understanding what they are investing in. This is all very good.
At the same time, it has been the aim of regulators to give private clients access to a significantly growing part of capital markets. Public markets are shrinking, private markets are constantly growing and will continue to grow, so it is important that private clients get access to some of the most attractive return sources in investing. Balancing that with making sure this happens in a safe way is something that is progressing step by step. That has brought with it new formats, such as long-term asset funds (LTAF), in the UK, and European long-term investment funds (ELTIF), as well as similar formats in some other countries that make it possible for private clients to invest in private equity.
However, what is holding up the adoption of private assets is not only having the right formats and creating the right products, but making sure investors understand what they are investing in. Educating investors is key. It is a big task for us as asset managers, and an even bigger task for the wholesale distributors – that is private banks – to make sure that what is getting sold is sold with the right explanations attached.
It is important that clients fully understand what they are doing, as well as the extent to which they can bear the illiquidity that comes with investing in private markets. That works more easily in certain parts of a private client’s asset allocation – in personal pension savings, for example. People need to understand that higher returns come with the price of sacrificing some liquidity. It is just not possible otherwise to achieve those returns.
How do approaches to private assets differ for institutional and individual investors?
Private clients typically have maybe one chip to put in the market per year, and not 10 or so investment decisions per year, so the way they go about constructing a portfolio, by definition, must be different. It also needs to be more convenient administratively. For private clients we see demand for a more diversified portfolio – for example, private equity, private debt and infrastructure combined in one portfolio; or diversified within one asset class, for example an Asia fund, or a thematic fund.
“People need to understand that higher returns come with the price of sacrificing some liquidity”
That is not so much the case for institutional investors, which typically need building blocks that fit their, often regulated, allocation buckets. So, dealing with private clients actually means offering private equity and private markets generally more in themes and in a more diversified way.
Of course, the wrapper is different from the typical institutional private market fund, because these are investors with specific requirements; they invest in an ELTIF or a semi-liquid fund and not in an LP structure, and then it is more thematic in the approach, more diversified and often embedded in a multi-private asset product.
We are also seeing a much bigger push and demand for sustainable themes. Taking the decision to, for example, invest via a DC pension in a way that is equally producing the financial return, but also the sustainability outcomes, is something you see more clearly coming from private clients.
How do you think the private assets landscape will change with this extra capital flowing in, particularly from DC pension funds?
We will see more capital going into sustainability themes. However, we need to put that into context. Private capital as a percentage of the overall capital going into private markets is maybe still only around 10-15 percent at the most. But it is growing every year, so you will see more capital pushing and moving into those mega-themes that define our times. Therefore, you will likely see capital going into, for example, other thematic areas such as innovation.
Historically, there has always been a lot of appetite from private clients in technology and venture capital, for instance around progress in healthcare or energy transition.
Are private equity’s fees a hurdle for DC pension funds?
The fee cap applies on the total portfolio level, it doesn’t apply for one single asset class. So, DC pension funds can pay typical private market fees, but it limits their exposure, because they need to make it up somewhere. There is perhaps a little bit of movement needed from both ends of the spectrum.
“We are seeing a much bigger push and demand for sustainable themes”
First, the regulator needs to loosen the fee cap for investment strategies that, by definition, are just more expensive to run. In private equity for example, you have to source a company, which is private, it is not just listed somewhere and you can simply buy its shares. You must find and negotiate the deal, manage the company, run a value-creation programme and, at some point, you need to find a good buyer to exit it to. This is not cheap for an asset manager to run, so regulators must be mindful of the work needed for certain strategies.
The other side, of course, is there are some ways to mitigate fees by asset managers as well. To some extent that is a function of scale, to another extent it is a function of, for example, using co-investments, which come with a slightly lower fee weight.
What are private clients’ return requirements?
They are seeking products at the midpoint, hovering around the 8 percent to maybe 15 percent mark. Secure liability matching income at 4 percent or 5 percent – which is what institutions need – is not really what a private client looks for. Very high risk strategies are sometimes sought-after, but they are not what we think should be offered to a broader market.
What types of investments work best for these new investors?
If I look into our own product universe, the share of secondaries and co-investments, rather than fund investments, in, for example, private equity portfolios is higher. The reason for this is quicker deployment and shorter duration – more liquidity being deployed more quickly into investments and coming back more quickly, if needed. Some investments are happening within semi-liquid funds, which have a degree of liquidity built in.
You want the client to have the experience that when they come in, their capital gets invested fairly quickly. That is very different from an institutional investor that can endure long J-curves from both a cashflow as well as from a return perspective.
How do you see the investable universe changing in the future?
Once new fund structures have started to establish themselves and proliferate, more investors will be investing into private markets to address their systematic underallocation. At the same time, the investable universe will also be growing. Private markets have historically been limited to private equity and real estate; for the last 15 years, there has also been private debt and infrastructure. Next may be natural capital and various digital assets.
As we move in the direction of digitised or tokenised assets – it’s a bit too early for this, still, but this is happening – let’s say over a five-year period, many more assets will become set up ‘on chain’. Consequently, the industry will increasingly be overcoming the bite size problem, and the friction costs of transferring assets from A to B will decrease. Right now, deals are very chunky, and it is very expensive to sell and buy a private asset.
If you imagine that trading becomes frictionless and more fractionalised in a tokenised world, the combination of both trends – democratisation and digitisation – is very interesting. You will have ever more investors investing in smaller and smaller chunks in private markets, and you have more frictionless and more fractionalised private markets, which together deliver significant growth potential. If you look at a maybe five-to-10-year horizon, this gives rise to another doubling at least of private markets.