Research article by Fabrizio Pagani, Global Head of Economics and Capital Markets Strategy, Muzinich & Co.
For ordinary retail investors, the opportunity to invest in private markets (e.g. private equity and private debt funds) has broadly been off-limits.
“A private equity fund is typically open only to accredited investors and qualified clients. Accredited investors and qualified clients include institutional investors, such as insurance companies, university endowments and pension funds, and high income and net worth individuals”.According to the Securities and Exchange Commission (SEC)
Typically, ordinary savers are excluded. Indeed, similarly restrictive rules apply to the majority of alternative investments.
Opportunities for Savers and the Broader Economy
An allocation into private markets offers the potential for healthy diversification, with demand reflected by strong growth in the asset class; in the last ten years, alternative assets under management have more than tripled – from US$3.1tn in 2008 to US$10.7tn in early 2019.
Treasury departments, especially in Europe, are eager to see domestic savings funnelled towards financing the real economy in order to broaden and diversify funding sources. Policy makers view a less bank-centric economic system as an encouraging development at the point that it can provide tax breaks for individuals investing in the real economy.
As highlighted by the UK government, the UK’s Individual Savings Account (ISA) scheme provides favourable tax treatment for retail investors and has been progressively opened up to include alternative asset classes.
In Italy, since 2017 the Piani Individuali di Risparmio (PIR) has provided private investors full exemption from taxes on capital gains if they buy equity or debt issued by Italian SMEs, including unlisted ones. France’s PEA-PME (Plan d’épargne en actions destiné au financement des PME) scheme, in operation since 2014, also facilitates retail investment in small businesses by providing better tax treatment. These programmes are contributing to transforming “private individuals and households from passive savers into more active investors, thereby increasing the opportunities for improved long term financial planning”.
In 2015, the European Union (EU) launched a new investment framework, the ELTIF (European Long-Term Investment Fund), which regulates private investment in non-UCITS funds, i.e. alternative products. ELTIFs can invest, with a long-term view, in equity and debt of EU-based SMEs, including unlisted companies, infrastructure and real assets. These funds are conceived for retail investors, but with certain limits in an effort to provide protection to ordinary savers.
For example, a private investor (with a portfolio below €500,000) cannot invest more than ten per cent of their portfolio into ELTIFs. However, this new vehicle did not receive immediate acceptance and uptake has been slow, likely due to the product’s innovative nature. Only recently have asset managers fully understood its potential, which has resulted in the successful launch of several ELTIF products.
Alternative investments have inherent characteristics, e.g. illiquidity, type of risk and concentration limits, which must be considered when they are marketed to retail. Therefore, the supervisory authorities strive to establish adequate information and disclosure requirements and risk mitigation principles. In the UK, in response to certain cases of malpractice, the Financial Conduct Authority recently introduced a new category of ‘funds investing in inherently illiquid assets’, subjecting them to additional requirements. In the US, in June 2019 the SEC launched a consultation on how to expand retail access to private markets.The consultation is ongoing and participation broad.
Balancing Risk with Reward
The right balance must be struck between facilitating funding for the real economy and providing adequate protection for savers as the regulators and supervisors strive to establish the correct disclosure and risk management requirements. Asset managers and distributors have a responsibility to comply with these requirements and ensure that these products are sold and marketed responsibly. Within the existing framework, the scope for further product innovation seems wide and deep.