“Tickets to get into the asset class were quite high… €10m, maybe €20m minimum to invest into the private equity fund,” said Mathieu Perfetti, head of private equity at Threestones. Consequently, financial institutions were the main investors in private equity, but they became constrained on the back of higher regulatory restrictions on capital when investing in alternative investments.

Perfetti was speaking during the “Broadening access to private markets” panel organised by CAIA Luxembourg, the local branch of the Chartered Alternative Investment Analysts association, last month.

“[Private investments] look complex, and kind of a black box. But basically, it’s a simple asset class, you’re investing into the real economy…. And it fits with what investors are looking for,” argued Perfetti. “Investors start to understand that… if you’re focusing your investments on listed products, you are missing a lot of investment opportunities [in SMEs].”

Delano noted the constant rhetoric by the private equity experts claiming that they invest in the “real economy,” which suggests that the public markets are not. Delano would argue that there are a large number small and mid-sized enterprises and financial institutions listed on stock markets that also contribute to the “real economy.”

Democratisation: is it hiding another agenda?

“There is also a strong willingness by the GPs to diversify the investor base,” said Perfetti. Siri Engqvist, managing director at client solutions at Troviq, confirmed the vast untapped capital potential for general partners, or GPs, as individual investors own “roughly 50% of total assets under management…but only 16% in alternatives.”

Besides, the “denominator effect” (over-allocation to private equity for some portfolio managers following the recent decline in the value of other liquid assets such as equities and fixed income on the back of higher interest rates) amplified the sense of urgency among GPs to find new source of funding. Engqvist also reported that KKR expects that “30% to 50% of new capital will come from wealth channels…whereas Blackstone expects its current $200bn in AUM to rise to $500bn.”

Delano wonders whether the democratisation of private investments is broadening its investor base out of necessity to assuage the backers of GPs rather than making sense for retail investors.

Yet will there be love for retail investors across the board?

“The democratisation is not so new…it started with ultra-high net worth (UHNW) some years ago, now high net worth and tomorrow retail investors,” reminded Alexandre Hector, partner in private banking & alternative investments at KPMG Luxembourg.

However, Engqvist explained that tapping the retail markets for GPs is more onerous given that “they have to build new capabilities that they are not familiar with” as they are now confronted with “lot of small clients with different time horizons and liquidity requirements.”

Veronika Zukova, head of product development at Société Générale Securities Services, suggested that the small-to-mid size GPs are not used to having cash in their funds to respond to potential early redemptions and that it may be too costly to operate a business aimed at reaching out to retail investor without a sufficient scale.

Given the operating complexity of reaching out to retail investors, Perfetti thinks that the distribution of private investments to these investors will take time, “a step-by-step process,” and that the democratisation process will start with professional investors. “We don’t expect, over the next 18 months, private equity [investments] everywhere in retail portfolios.”

Education for all

“The bankers who advise the clients must be convinced on the benefits to invest in private markets,” commented Engqvist. “The products offered to retail investors have to be simplified…having seen a move from a subscription capital call model to subscriptions and redemptions,” said Zukova.

The retail investors, the distribution network, and the GPs, i.e., the full ecosystem, “need to [better] know each other starting with the type of products, the type of assets, and how it would work on a day-to-day basis,” stated Perfetti. He commented that GPs will need to adapt to a process in which they will not be in contact directly with their limited partners, or LPs.

What if your manager is strongly underperforming?

Questioned by Delano on educating retail investors and telling them that they may have to stick with a fund and a GP for 10-12 years even if a fund is hypothetically strongly underperforming, Engqvist suggested that “the selection of the manager is key.”

On the back of 10 years of free money and high leverage, Engqvist admitted that it has been difficult to separate the wheat from the chaff. “We try to find managers who have a very defined toolkit and a defined deal type and to do that repetitively.” She added: “outperformance, in my view, will come from alternatives because of secular trends… and manager selection is key.”

Zukova added that traditional asset managers don’t have the same tools and are not as close to the management [as GPs] to influence the performance of their assets.

Resilience of fee structure for GPs, less so for distribution network

Engqvist noted that GPs managed to maintain their fee structure at “almost the same level,” an observation confirmed by Perfetti, who commented that “the 2/20 [fee structure] has never been really challenged” despite being seen as “too expensive” after the great financial crisis.

However, Engqvist commented that the same cannot be said of the distribution network, which saw fees moving lower, emphasising the need to use technologies when onboarding thousands of clients. This is a positive development as “most of the GPs don’t want to interact directly with [retail] investors,” noted Perfetti.

Will the next crisis protect investors or GPs?

“I think that the biggest protection that the retail investor needs is from itself,” said Zukova. “If you do not make it too liquid, it’s actually better… if there is a mass panic… a run for the money in a more closed structure is not possible, therefore, they [retail investors] can just weather the storm.”

“Transparency and reporting… will be important to win the acceptance and confidence of new investors,” said Engqvist. Thanks to regular communications on the status of investors’ portfolio and investments, “it will be easier the day when things are a bit tricky and markets are down… when you’ve seen it coming. It’s not going to be a big shock, hopefully.”