21 FEB, 2023
By RankiaPro Europe
By Georg Wunderlin, Global Head of Private Assets at Schroders.
The investor base for private assets is broadening. We explain how private investors entering the market will change the landscape. Private markets continue to evolve, and as they do, the investor base continues to broaden. Interest from two new investor types in particular, is rising fast.
• High-net-worth investors
• Affluent investors.
For high-net-worth investors, we expect each investment or “ticket” to be approximately €100,000 to €200,000. Affluent investors will likely invest around €10,000. Then, of course, there are defined contribution pension funds increasingly becoming active.
This shift has been happening over several years. Every year we see more capital coming in from those new sources, while traditional institutional investor flows are staying pretty much stable.
Is this “democratisation” changing the nature of private assets themselves?
Regulators have given considerable thought to the issue of private asset complexity for retail clients. The Alternative Investment Fund Managers Directive was launched several years ago to essentially eradicate, among other things, the so-called “grey capital” market. This is the unregulated end of the private client capital market, often related to private assets.
The industry now is far more regulated. Managers are regulated, and new fund structures have been created that are subject to much more rigorous control. This includes criteria like minimum diversification or maximum foreign currency exposure. It also covers the way products are sold and explained to clients, as well as gauging how clients qualify, or demonstrate, their understanding of what they are investing in. All of it is welcome.
At the same time, public markets are shrinking and private markets continuing to grow. Regulators are keen to enable private client access to a significantly growing part of capital markets, so as not to exclude attractive return sources. It remains vital of course, that this progress is balanced with safety for the investors.
The balance has led to new formats such as long-term asset funds (LTAF), in the UK, and European long-term investment funds (ELTIF). Similar formats are emerging in other countries to make it possible for private clients to invest in asset classes like private equity.
Where we believe more progress is needed now, is in investor education. As asset managers it’s a big task for us, and an even bigger for the wholesale distributors – such as private banks – to make sure investors receive the explanations they need.
It is important that clients fully understand what they are doing, and are clear on the extent to which they can bear the illiquidity of investing in private markets.
That works more easily in certain parts of a private client’s asset allocation – in personal pension savings, for example. People need to understand that using private markets in pursuit of higher returns comes with the price of sacrificing some liquidity. It is just not possible otherwise to achieve those returns.
Once new fund structures have started to proliferate, more investors will be investing into private markets, likely augmented by the addressing of “systematic” under-allocations; the allocations they could have had if it were not historically difficult.
At the same time though, the investable universe will continue to grow. Private markets have been limited to private equity and real estate for much of their history. Over the past 15 years, there has also been greater use of private debt and infrastructure.
The next markets to grow and mature may be natural capital and various digital assets. As digitised or tokenised assets grow in importance, many more assets will become set up ‘on chain’.
A consequence of this would be the industry increasingly overcoming the “bite size” problem; making investing by smaller increments easier. The costs of transferring assets from A to B would also decrease.
Right now, deals are very chunky, and it is very expensive to buy and sell a private asset. If you imagine that trading becomes frictionless and more “fractionalised”, the combination of both trends – democratisation and digitisation – is very interesting. Over a five-to-10-year horizon, we could see as much as a doubling, or more, of private markets.
Private clients will typically make one private market allocation per year. As a result, the approach to constructing a portfolio must be different.
It needs to be more convenient administratively. For private clients, we see demand for more diversified portfolios – for example, private equity, private debt and infrastructure combined in one portfolio. It might also be diversified within one asset class, for example an Asia fund, or a thematic fund. That is not so much the case for institutional investors, which typically need building blocks that fit their – often regulated – allocation buckets.
Private capital is still only set to represent about 10-15% of the overall capital going into private markets annually, at the most. But it is growing every year. We expect to see more capital pushing into mega-themes like sustainability, or innovation. Historically, there has always been a lot of appetite from private clients in technology and venture capital, for instance around progress in healthcare or energy transition. Investing via a DC pension in a way that is equally producing the financial return, and sustainability outcomes, is something you see more frequently from private clients.
The wrappers used by private clients also differ from the typical institutional private market fund. Private investors have specific requirements, so they might use an ELTIF or a semi-liquid fund, not an LP structure, as is more traditional. Then it is more thematic in the approach, more diversified and often embedded in a multi-private asset product.
The fee cap applies on the total portfolio level, it doesn’t apply for one single asset class. DC pension funds, for example, can pay typical private market fees, but it may limit their exposure, because they need to make it up somehow. There is perhaps some movement needed at both ends of the spectrum. First, the regulator needs to loosen the fee cap for investment strategies that, by definition, are just more expensive to run.
In private equity for example, sourcing private companies is more complex; the shares are not listed somewhere and can’t simply be bought. You must find and negotiate the deal, manage the company, run a value creation programme and, at some point, you need to find a good buyer to exit it.
This is not cheap. Regulators must be mindful of the work needed for certain strategies. On the other side, there are some ways for asset managers to mitigate fees. To some extent that is a function of scale. To another, it might be a function of, for example, using co-investments, which come with a slightly lower fee weight.
Anecdotally, private clients are seeking returns hovering around the 8-15% mark. Secure liability matching income of around 4-5% – what institutions need – is not really what a private client is looking for. Very high risk strategies are sometimes sought-after, but they are not what we think should be offered to a broader market.
In our own product offering the share of secondaries and co-investments – rather than private equity fund investments – is higher. The reason for this is quicker deployment, and shorter duration. This means liquidity being deployed more quickly into investments, and coming back more quickly, if needed.
Some investments are happening within semi-liquid funds, which have a degree of liquidity built in. You want the client to see their capital get invested fairly quickly. Institutional investors can endure long J-curves. This describes the return profile of institutional capital being invested over time, to then create a portfolio that generates returns further down the track.