Schroders Capital: Riding the democratisation wave

This article is sponsored by Schroders Capital.

For a long time, private markets were viewed with caution by many wealth managers. Today, as the investable universe of private assets has expanded – becoming ever more sophisticated as it grows – the opportunity set has become too big to ignore.

Nathalie Krekis, portfolio director at Schroders’ wealth management business Cazenove Capital, and Georg Wunderlin, global head of private assets at Schroders Capital, tell Private Equity International that a key part of their role is to educate individual investors on the benefits of allocating to private markets. A much broader range of investors are now able to access private asset classes through innovative structures – although, according to the pair, regulatory changes and technological progress are still needed to complete the democratisation of the asset class.

Private assets have tended to be a controversial subject within the personal finance industry. Can they be an appropriate asset class for individuals?

Nathalie Krekis: We recommend a diversified approach, in which individual investors allocate sleeves to different parts of the market. Today, private assets should absolutely be one of those sleeves. 

For an individual investor, having a portion of your wealth in private assets is crucial if you’re going to generate the types of returns that you’ve achieved historically. While the outlook for economies and markets looks challenging from here, historic data tells us that investing in private markets during times of crisis or stress can generate some of the best returns in the future.

Additionally, we are seeing mounting evidence that companies are deciding to stay private for longer, so investors are missing out on huge growth potential if they ignore the vast number of companies that are not publicly listed. Just a few years ago, it was very difficult to invest in private markets unless you could write a multimillion-dollar cheque. That’s shifted now, partly because of technology. Being able to offer clients a wider suite of investment vehicle options is brilliant from my perspective.

What does the current macroeconomic environment mean for individuals investing in private markets?

Georg Wunderlin: In private markets, vintages that are launched in economically challenging years are typically the best performing. That’s not surprising: what happens in private markets is a repricing of assets, and there is also a time delay compared with public markets. 

Over the course of 2023, you should expect private markets to adjust to the current economic situation; this will generate investment opportunities at more attractive pricing, with less competition from those seeking to invest into the same deals. If people are thinking about allocating to private markets for the first time, the time is now.

How does scrutiny from regulators affect individual investors’ ability to access private markets? 

NK: It’s absolutely right that regulators provide scrutiny. Investors are locking their money up for long periods, so there has to be scrutiny. 

It’s so important that investors have a trusted adviser who fully understands the regulatory backdrop and what the regulator is trying to do. Crucially, the adviser also needs to interpret regulations so they can continue to invest in private markets on behalf of individual investors. 

We’re fortunate to have a well-resourced compliance department that understand the rules and makes sure we’re adhering to the regulations but does not shut off this asset class entirely. There is the possibility that some of the more boutique-like wealth managers, who are less resourced, won’t have the capacity to do this because they struggle to keep up with the ever-changing regulations around private markets.

What regulatory changes are needed to help accelerate the democratisation of private markets?

GW: Regulators certainly understand that they need to find adequate ways to give individual investors access to private markets. Public markets are shrinking, and private markets are becoming an ever-larger part of–capital markets.

Governments have generally been helpful in creating new formats that provide access to individual investors. Long-term investment funds (LTIFs) or long-term asset funds (LTAFs), for example, provide a structure that is investable for a broader base of investors, not just those who are part of the ultra-high-net-worth class.

The area where more effort is needed is DC pensions. Private pensions are the one corner of the market where any individual investor can most easily tolerate illiquidity. The right formula hasn’t been created yet to make sure the mass audience, through their private pensions, can access private markets; it’s still relatively difficult for providers of DC pensions savings products to embrace private assets.

What kinds of structures are being developed to serve the investment needs of different types of individual investors?

GW: The biggest difference between different types of investors is their ability to tolerate illiquidity. Family offices and UHNWIs are able to invest into feeder funds; these have been around for a long time. But recently, access to feeder funds has become easier through technology. For example, onboarding processes in illiquid funds, which tend to be very complex and cumbersome, have been streamlined by digital platforms. That makes it much easier, both for the investor and for us as an industry, as we now can administrate a large number of investors in an illiquid fund.

We also see a lot of innovation in structures aimed at HNWIs. Semi-liquid funds are the most versatile and noteworthy innovation: they are essentially designed as an evergreen fund with regular subscription and redemption windows. As the fund creates exits, investors are able to get their money back. The format is very useful for a broader audience because semi-liquid funds overcome the complexity of capital calls, which many private investors find hard to deal with. But they’re still only suitable for qualified investors – the typical minimum is around $100,000 to $200,000, depending on country.

For investors who can invest between $10,000 and $100,000 – still fairly wealthy people – ELTIFs and LTAFs are an option. These are illiquid funds that have certain criteria around diversification and the universe of investable assets. It’s a newly evolving field that is not broadly established at present, but we do see increasing appetite for these kinds of investments.

What else is needed from financial advisers to help individuals invest in private markets?

NK: A trusted adviser needs to understand their clients’ overall wealth position: the assets the client invests with them, the assets they hold elsewhere and their current and future spending patterns. Having that full understanding of the client’s liquidity needs is crucial so they can make the right assessment of how much they can tie up in private assets.

On the admin side, the client does not need to do anything. In terms of meeting capital calls and managing distributions, everything is handled on our side. From the client perspective, it’s a big relief to have that taken out of their hands. 

The key for us as financial advisers is to be able to invest on a discretionary basis. Right from the outset, we discuss with clients what the journey should look like over several years – after that, it’s up to us to have discretion over it and where is the best place to deploy their capital.

The really important thing is to invest consistently year after year. After five to seven years, depending on deployment of capital, your private assets portfolio should start to become self-financing as earlier investments made begin to return capital to the investor. We can then use that capital to redeploy to new opportunities. It’s also very important to remember that no two vintages are equal, and thus by allocating capital to new opportunities each year, it can smooth your overall return profile.

What is the future outlook for democratising private markets?

GW: The universe of investable private assets is growing constantly. What’s still an impediment for asset managers, however, is the inability to break down deals into smaller chunks and to overcome the burden of transferring an asset from A to B. But, by using new technologies, such as blockchain, it will become easier to fractionate private assets and make trading more frictionless. 

Democratisation, in that regard, can really be seen as a mega-trend. Five or 10 years from now, we won’t be talking about democratisation anymore – we’ll simply expect that everyone will be able to access smaller digestible bite sizes of illiquid assets and trade them fairly easily. The difference between what we now consider public and private will become smaller – I don’t think we’ll look at that in the same way five to 10 years from now.

What are the major factors that individual investors should consider when they begin to incorporate private assets into their portfolio?

Georg Wunderlin: What’s really important is that investors understand private market products are very long term. There is no possibility of trading in and out. Once an investor has come to the realisation that private market assets are attractive, they need to invest in an almost programmatic manner. Investors need to commit every year and diversify their vintage years. Investors need to understand that exits – which will happen five to seven years after the initial investment – might take place in an entirely different economic context. 

Ultimately, there is no crystal ball for anyone. That means individual investors have to make a decision based on how much they can commit every year to private markets – almost thinking independently of the current capital market environment.

Nathalie Krekis: No two clients are the same – they have different liquidity profiles, different time horizons, and different needs and objectives in their portfolios. And, of course, their tolerance and appetite for risk can vary massively.

A big part of what we’ve been doing is educating our clients. Many of our customers will have spent years allocating through investment trusts and other vehicles listed on the public markets, enabling them to trade in and out at premiums and discounts. We help them get into the mindset that locking up their money for longer is something that, very often, they can also do. If I look across my client base, often their money has been invested for decades and they’ve never touched it – so they can already afford the level of illiquidity that private markets offer.