Educating retail investors and other stakeholders is crucial for expanding private markets’ reach into the retail investor segment – sometimes called the democratization of the asset class, panelists noted during a discussion at a New York roadshow last week for the Association of the Luxembourg Fund Industry.
Arnaud Bon, a partner at Deloitte who works in its advisory and consulting group, touched on investor awareness.
“How do we make sure that your end investors, who are not necessarily super educated about alternative products, basically fully understand that it’s not going to work exactly as a mutual fund, a traditional mutual fund?” he said.
A low degree of retail participation was even observed in the speaking room.
Panelist Brian McMahon, a managing director at BNY Mellon who works on alternatives business development, instructed people to raise their hands when he asked if they could invest in private markets outside of their own firms, finding that hardly anyone does so.
“If this audience can’t invest, how do you get Joe Public to invest?” McMahon said.
In private equity, democratization has been a topic of interest among GPs that have eyed retail investors as a potential fundraising source to help them reduce their traditional reliance on institutional LPs such as pensions. The denominator effect is spurring this interest because big LPs are cutting their commitments to rebalance their asset allocations, affiliate title Private Equity International has reported.
But widespread adoption has been limited due to insufficient education among smaller investors, and the potential for GPs to incur reputational damage if those investors don’t sufficiently understand their investment risks, per PEI.
Vivian Sze, a director at Apollo Global Management, noted that one potential roadblock to retail investor adoption is that private markets may not come to mind when they think of alternative assets.
“When an everyday retail investor thinks about alternatives, I don’t know if they’re actually thinking private equity, right? Or private debt,” she said. “They’re really thinking liquid alts, they’re thinking hedge funds.”
Sze said her firm recently launched a free educational program called Apollo Academy. Citing clients’ feedback, she added that resources like the academy can help “people understand that alts doesn’t have to be scary.”
Panelists noted that private asset managers looking to enter retail will face challenges in adjusting to liquidity and compensation differences.
For one thing, they may have to live without carried interest.
“All alternative players want to have carry, but carry in an open-ended structure just doesn’t fly,” Bon said.
New entrants will have to adjust their cash management practices to meet investor redemption requests. “A private manager typically has very little cash,” McMahon said.
Bon addressed the objective of avoiding the imposition of redemption limits, or gating of funds, due to insufficient cash on hand. He also spoke about the need to balance how much cash managers should retain, as keeping too much can hit fund performance.
“How do you make sure that this liquidity bucket is not going to kill your IRR basically, and let’s try to minimize it, but to size it sufficiently so that we avoid the gate,” he said.
Sze noted that there’s an ongoing debate for how asset managers should design retail fund liquidity.
“We’re trying to figure out which are the exact features, the right metrics that are going to resonate,” she said.
Another educational challenge lies on the distribution side.
Bon said that established retail fund salespeople need their own education, particularly those who are used to selling mutual funds. He pointed to historical challenges, such as wealth managers lacking internal company governance that would incentivize them to distribute alternative investment products.
Legislators also need education, said panelist Stefan Staedter, a partner at Arendt & Medernach who works in its investment management practice. Bon said that European policymakers, who have previously bashed alternatives, are now more receptive because of their potential to drive economic growth.
Sze touched on the market opportunity for attracting retail investors to private markets, and the challenges managers face in expanding their capabilities to cater to these potential clients.
Investors aren’t seeing their desired returns in the present market environment for their existing asset types, Sze noted.
“They’re faced with basically saying, ‘I can’t achieve my longer-term targets investing in the stuff that we’re investing in today, so I need something new,’” she said.
Established asset managers looking to gain retail customers in private markets face challenges in figuring out how to expand, Sze explained.
Traditional alternative managers may face the question of how they can broaden their distribution, she noted, with acquisition and hiring as potential paths forward. Sze added that traditional long-only managers may face questions of how to add capabilities and how to “spice up” lineups of their offerings to avoid product commoditization.