Tim Boole, Head of Product Management at Schroders
Demand for private assets keeps rising, and not just among the traditional institutional investors. We look at how private markets are “democratising”.
In the past, private assets – like private equity – have been accessible only to large institutional investors.
But that’s changing.
One of the main reasons private asset investment has been out of reach for private investors until now is the nature of transactions. It can be very time consuming to source deals and complex to structure them, while exits can also take a long time and pose their own difficulties.
However, demand from private investors has been growing. Many of the large private asset managers that previously catered only to an institutional client base are developing more accessible products.
So what has led to this change? What does it mean for the industry? And what does it mean for smaller, private investors?
Here we explain the product, technology and regulatory developments that are opening the doors of private asset investment.
Demand heating up, supply is responding
The chart below shows a demand “heat map” for private assets. The growth among high-net-worth investors (HNWI) is expected to be faster than the traditional sources of capital, like endowments.
It’s important to note that the underlying asset classes haven’t changed.
An infrastructure loan can have a life of 30 years, and a private equity owned company a typical ownership period of 5-8 years. Neither of these facts have altered.
However, regulation around who can hold private assets has started to loosen, while technology is simultaneously breaking down the barriers of illiquidity. This means the supply of private asset vehicles that private investors can use is growing rapidly.
How have products evolved?
The fund structures used to access private assets can be grouped in two buckets: open-ended or closed-ended. These can be split into three degrees of liquidity; liquid, semi-liquid or illiquid.
Semi-liquid open-ended funds
Innovation in open-ended semi-liquid funds, especially for asset classes such as private equity, private credit and real estate, has been progressing rapidly. These feature monthly or quarterly subscription and redemptions cycles. Liquidity comes from two sources:
1. Investor subscriptions and redemptions
2. Investment distributions.
Subscriptions and redemptions are at the fund’s net asset value (NAV). This removes the volatility or market beta compared to closed ended funds, which rely on a secondary market for liquidity.
The liquidity management in a semi-liquid funds is achieved through portfolio construction and liquidity management tools. Portfolio construction provides the first line of defence. A well-constructed portfolio, one that is diverse by geography, sector, type and vintage, can engineer a level of “natural liquidity” that is regular and consistent. When we ran various simulations across our private equity investment programmes, we found that in all but the more extreme market situations, the level of natural liquidity was more than sufficient.
As a second line of defence, semi-liquid funds often use tools such as redemption caps or the possibility to suspend subscriptions and redemptions so the manager can better control liquidity within the fund. An associated objective is that by using these liquidity tools, it helps to moderate investor behaviour in the event of market stress events. If an investor knows they would have to wait three to six months before they can exit a fund, they are less likely to exit impulsively.
Liquidity management also needs to be considered in terms of cash subscriptions to the fund, as cash balances can lead to a performance drag.
Closed ended listed funds
Whilst semi-liquid funds have improved access for investors, there are a number of investment strategies that are still best accessed via closed ended funds. There has also been a high level of innovation in this space.
Closed ended listed funds – better known as investment trusts in the UK – offer private investors an ideal means of accessing a private portfolio while retaining the flexibility of daily dealing.
One of the fastest areas of growth has been the launch of closed ended funds with no liquidity or periodic liquidity windows. There have been a number of new web-based platform launches in recent years that offer private investors access to a wide variety of private asset strategies through feeder funds. Technology has helped bring down a lot of the upfront and costs and complexity in offering these feeder funds to new investors.
Regulatory changes – covered later in this article – have also opened up more opportunities for new fund launches . These new closed ended fund structures are designed specifically for private investors, by having a structured capital call schedule, a shorter fund term than more institutional orientated funds and lower minimum subscriptions amounts.
How is technology helping?
Technology has been a significant catalyst in the democratisation of private assets in several ways.
One of those is the development of new platforms that allow entrepreneurs to raise equity from seed investors where previously they may have been confined to friends and family. Internet based platforms include Seedrs (UK), SeedInvest (US) and investiere.ch (Switzerland). Entrepreneurs can pitch their ideas and start-ups to private investors who can choose the amount to invest, even with small amounts such as $500. Similar concepts apply in real estate.
The concept has also extended to private credit, traditionally the exclusive domain of banks and specialist lenders. In private credit, democratisation is known as peer-to-peer lending. Private investors can choose to provide loans to individuals or companies for higher returns than would be available through traditional savings accounts or fixed income securities.
Other ways technology has opened up access to private assets is via new distribution and communication channels. Registration of new investors is automated, reducing the time and cost of onboarding new investors, that previously relied upon a branch network or paper-based process. Similarly reporting can be digitised, which helps reduce the cost for investment managers to make it more economical for small subscription amounts.
We are excited by the prospect of further innovation that will help further support the opening up of private assets. This includes the prospect of “tokenisation”, which can open up new ways for investors to access private assets without some of the restrictions that fund structures can sometimes apply. By being able to provide investors with a digital right of ownership over an asset using blockchain technology, the cost to the investor for having a share in the ownership of an asset reduces significantly. Similarly, it also opens more flexibility when it comes to liquidity.
Regulation shifting to facilitate private asset access
Regulation still poses challenges to the democratisation of private assets and our experience is that changes in regulation have been uneven between markets. However, many governments recognise the growing role of privately sourced capital as important for economic growth and job creation. Retail investors provide a source of capital to an economy. There is growing emphasis on updating regulatory frameworks to facilitate access and to ensure retail investors are not restricted from the higher returns that have been generated historically from private investments.
Examples of new regulation in Europe include the European Long Term Investment Fund (“ELTIF”) and in the UK the planned Long Term Asset Fund (“LTAF “). Both structures provide a regulated means for sophisticated retail investors to access private asset investments. In the US, the Department of Labor has ruled that 401K plans could invest in private equity, since further clarified in January 2022 to be subject to plan suitability.
However, given the pace of technology and innovation, it has led to situations where the regulatory guidelines struggle to be applied in the purpose they were originally intended. It is a delicate balance that regulators must navigate to open up access while ensuring that their primary role of protecting investors is maintained.
Further democratisation of private assets looks certain. Whether the pace stays the same will be determined by macro factors and the changing regulatory environment.
The democratisation of private assets: how will it work?We believe that access and liquidity will continue to evolve and support further opening up. Interestingly, this also leads to a situation where the distinction between private assets and listed securities becomes less pronounced and the ownership status less of a factor in the investment strategy. We are already seeing this development in parallel with the growth of public-private funds.