Are Retail Investors the Next Frontier for Private Equity?
Wealth advisors and institutional consultants are increasingly offering private equity options to retail investors, but they come with a variety of hurdles and risks
Institutional private equity fundraising continued its slide this year, and many LPs are already oversaturated on private equity. In the first quarter, 150 private equity funds closed with $166.8 billion in capital commitments, representing a 38% decline from the same quarter last year by volume and a 6% decline by dollar value, according to Preqin.
Moreover, most U.S. institutional investors already have private equity programs in place, with some reporting that they’re overallocated to private equity because of the liquidity mechanisms and stock performance in recent years. This is leading to the pursuit of other avenues for growth. For some firms, that means increasingly tapping international investors. For others, it’s turning to retail investors.
So far, most of the activity has been among private wealth banks and registered investment advisors (RIAs) that offer private equity as an option in retail investors’ portfolios or as part of a mutual fund offering. “Private banks and wealth advisors have been raising money from individuals for private markets for a number of years,” says Jessica Mead, regional executive for North America at fund administrator Alter Domus. “These are usually smaller, semi-liquid fund structures, with redemptions capped as a percentage of NAV,” she adds.
Some of the largest private equity firms, including Blackstone, Apollo Global Management and KKR, have also launched dedicated funds for retail investors. Most recently, Borgman Capital, a lower middle-market investment firm in Wisconsin, launched its Pass the Hat platform, which gives accredited investors access to Borgman’s portfolio. Still, experts cite a variety of hurdles when it comes to getting retail investors—who are used to daily liquidity—into long-dated private equity funds. More frequent performance reporting, transparency and other nuances are in play.
Access Pathways
A variety of private banks, RIAs and other wealth advisors have started to offer private equity as an investment option to their retail clients. Some come in the shape of “interval funds” that have limited liquidity options; others are private equity investments offered to end-clients in a menu of options.
Thrivent, a Minneapolis-based financial services firm, announced in April that it was now offering private equity as an asset class in its Asset Allocation Funds/Portfolios. Retail investors can gain exposure to private equity funds for as little as $50/month. The firm’s four asset allocation funds will eventually build to a 4-6% allocation to private equity spread across a highly diversified portfolio of PE funds, says David Royal, chief financial and investment officer at the firm. “We wanted to include private equity as a diversified asset class,” he says. The allocation is starting at six secondary funds-of-funds to get broad exposure to private equity across primarily domestic middle-market buyout funds. The mutual funds offer daily liquidity—a stark contrast to the long lockups typical of private equity.
Royal says Thrivent ran a variety of models and scenarios based on past redemption rates through market cycles. He doesn’t think sudden significant withdrawals from clients would necessitate pulling money from the private equity funds. “Our redemption rates have been low historically, even in the worst-case scenarios,” Royal says. “We don’t have any significant shareholder concentration.”
Thrivent also manages $75 billion in insurance assets and has a dozen people who manage private equity, primarily focused in the middle-market buyout space for the organization’s general account. The same team worked on doing a search for the secondary funds-of-funds for the retail channel, Royal says. “We had a group of experienced professionals who were qualified to do a search for secondary funds-of-funds. From a risk/return perspective, the middle-market looked more attractive [than large-cap],” he adds.
Meketa Investment Group, an investment consulting firm that advises pension funds and other institutional investors, also used its experience to give retail clients access to private equity. The firm launched its Meketa Capital and Meketa Infrastructure Fund subsidiaries in February. Meketa Capital offers retail investors exposure to private equity co-investments via an interval fund that acts like a mutual fund but has quarterly liquidity and a 5% cap on money that investors can withdraw at one time. Other products in this space include “tender funds” that also have quarterly liquidity but a board has the right to suspend withdrawals.
Meketa Capital CEO Michael Bell says the firm partners with 60-80 preferred private equity managers that Meketa has worked with via its institutional arm and invests directly in portfolio companies through co-investments. Most of the exposure is in North American funds that are diversified by vintage year and sector, he says. The firm has made 20 investments to date since January. “We’ve been sourcing co-investment work with these firms for decades. The diligence is based on long-standing relationships,” Bell says.
Most private wealth banks and RIAs are putting 5%-10% of retail investors’ asset allocations into private markets or other alternatives, Bell says. He thinks over time that exposure could grow to 20%. Typically, capital is cut from small and mid-cap public stocks and diverted to alternatives.
Wealth advisors that are new to the world of private equity can benefit from the knowledge of more experienced participants that understand the return differential between top and bottom quartile managers, for example, and the liquidity expectations of private equity investments.
“Wealth management firms are exploring this as a new frontier. They are not familiar with the space; they need someone to guide them through this effort,” Bell says.
Wealth management firms are exploring this as a new frontier. They are not familiar with the space; they need someone to guide them through this effort.
Michael Bell
Meketa Capital
GPs with Their Own Products
Some of the largest private equity firms have launched mutual funds that offer retail investors access to their private markets platforms. Blackstone raised $1.3 billion in January for its BXPE retail fund, according to The Financial Times. The offering invests in traditional buyouts, biotechnology and preferred equity. KKR launched its K-Series of private markets funds for retail investors last year, with the first strategy named K-Prime. The firm said it raised $500 million per month for the strategy from affluent investors. Apollo executives, meanwhile, have said they plan to offer private credit opportunities to retail investors and exchange traded funds, according to comments made at a conference in May.
Fees on these retail funds are usually lower than institutional funds (2% management fees and 20% performance fees). The retail funds typically charge a 1%-1.25% management fee and a 12%-15% performance fee, with a 5% hurdle rate.
In May, Borgman Capital launched its Pass the Hat online platform for retail clients. The strategy offers accredited investors access to Borgman’s portfolio companies at a $50,000 investment minimum. Prior to launching Pass the Hat, the announcement said the firm had completed 18 investments with commitments from high-net-worth individuals and family offices. With Pass the Hat, the goal is to make it easier for additional accredited investors to access private equity. The platform has lockup periods of five to six years, similar to other private equity investments, according to CEO Sequoya Borgman. He notes that private equity is the only alternative investment not broadly available to retail clients yet.
Borgman says the firm “soft launched this strategy to test the market,” and it remains to be seen how successful the retail channel will be.
Getting Started in the Retail World
Executives at SS&C GlobeOp, the fintech company’s fund administration division, say that retail investors are becoming more aware and educated about private equity. “Private equity is buying so many corporations, the average investor wants that exposure,” says Bhagesh Malde, global head of SS&C GlobeOp. Where retail investors would normally get access through public stocks, there aren’t as many of them available. According to The Atlantic, the number of public companies has shrunk by half (from 8,000 to about 4,000) between 1996 and now. The share of total companies under private equity ownership, meanwhile, has grown from 4% to 20%. Given the latest developments in take-private deals and limited IPOs, the trend is expected to continue.
Private equity is buying so many corporations, the average investor wants that exposure.
Bhagesh Malde
SS&C GlobeOp
Malde says there is interest “in the ability to democratize these investments” and predicts that private markets or alternatives exposure could grow to 10% of retail clients’ portfolios in the coming years (from 5% or less now). “I think it’s a global trend,” he adds. “Consumers in India are also clamoring for exposure to private equity and real estate.”
Even as firms look to capitalize on the growing interest in private equity, setting up a retail strategy involves a lot of back-office work, anti-money laundering mechanisms and figuring out the right liquidity mix. For its part, SS&C GlobeOp helps clients with automating and digitizing the onboarding process and preparing the paperwork for accredited investors.
Tapping into the retail channel for private equity also involves courting investors over time. “You won’t be able to set this up tomorrow; you have to build relationships through banks and advisors,” Alter Domus’ Mead says. Private markets firms must also turn data around quickly and respond to greater transparency needs and likely monthly (as opposed to quarterly) reporting.
When it comes to vetting private equity investments, “I think retail investors place a lot of trust in who it is,” Chansky says. “Whether it’s an independent financial advisor or a large private bank, investors rely on the advisor to do the underlying homework and due diligence on the product. Education by the product sponsor is a big part of it.”
Anastasia Donde is Middle Market Growth’s senior editor.
Middle Market Growth is produced by the Association for Corporate Growth. To learn more about the organization and how to become a member, visit www.acg.org.
