While we forecast global private capital markets to reach $18tn in size by 2027, the portion of retail investor involvement in that likely remains in the low single digits. However, we expect it to increase significantly.
Fund managers are pivoting to retail as institutional fundraising slows
The retail fundraising drive comes as a growing proportion of institutional investors move closer to their long-term strategic asset allocations to private capital. While there are plenty of markets around the world where many institutional investors have significant headroom for further capital deployment, some institutional investors in the US and Europe are approaching their strategic asset allocation targets. As this takes place, a larger share of fundraising is typically left to re-ups with existing strategies and relatively fewer fresh fundraising opportunities become available.
We forecast that global private capital fundraising will reach $1.6tn by 2027, representing a relatively modest 3.6% CAGR from $1.3tn in 2021. Having said that, a primary reason for this is the expected decline in fundraising in 2022 and 2023 on the back of the current macroeconomic challenges. The denominator effect is expected to weigh on allocations, curbing the willingness and ability of some LPs to allocate fresh capital. Our June 2022 investor survey confirmed that a large proportion of institutional investors are planning to slow their pace of capital commitments to private equity in the next 12 months.
A large share of retail investors will not suffer this affliction, given much lower existing allocations. They may nevertheless remain comparatively risk-averse, given the tighter liquidity conditions and slowing growth.
Retail demand for private capital
Retail investors remain under allocated to private investments. There are similarities between the incentive for retail investors and institutional investors to diversify into private markets. As with most portfolios, an investor can usually afford to leave a portion illiquid. The payback is the expected illiquidity return premium over time. But a lack of transparency in, and knowledge of, private markets has often held some investors back. Diversification also remains one of the key attractions of private market allocations, especially when the number of public companies in which to invest is diminishing, as companies stay private for longer. However, the main attraction is perhaps the prospect of higher expected returns, which have so far been largely reserved for institutional investors.
The addressable market has also been rapidly expanding. According to Capgemini, the number of high-net-worth individuals (HNWIs) globally grew by 7.8% in 2021
and accounted for $6.4tn in wealth. Having said that, the increase in 2021 was largely driven by the spectacular performance of technology companies that year – much of which has since unwound. Nevertheless, the long-term picture remains positive.
The risks associated with investing in private markets may be less well understood by retail investors. One particular concern may be the emergence of solutions that over promise when it comes to providing liquidity in the secondary market. The ability for individual investors to sell fund stakes on a secondary platform may appear attractive, and even help to induce flows into funds. However, providing liquidity for what are ultimately illiquid underlying assets can lead to obvious challenges should market conditions take a turn for the worse.
Regulators in the US and Europe have generally been proactive in facilitating the increased demand for retail investors into private markets. Governments are increasingly supportive of forms of long-term financing that can help to deliver infrastructure projects, and they provide finance for small business. It is also seen as a way of encouraging the public to save more and improve their chances of being able to meet their retirement goals.
US retail investors
Some of the largest private equity managers globally are taking the lead on raising capital from retail investors, which may set a precedent for the rest of the industry. US private equity giant, Blackstone, raised capital exclusively from institutional investors a decade ago. Currently, approximately 20% of the firm’s alternatives AUM has been raised from individual investors – and it may rise to around half. The firm estimates that the total addressable market amounts to $80tn.
Other large fund managers are starting to make moves too. One firm that is launching a fund tailored to the needs to HNWIs is Apollo Global Management. A new $15bn fund
the firm is launching will allow HNWIs to invest alongside institutional investors.
For private equity in the US, retail access has been predominantly limited to qualified purchasers (QPs) under the Investment Company Act of 1940. Investment vehicles have simply not been designed for retail investor participation, given minimum investment sizes. However, the SEC is being very proactive in seeking to improve retail access to private markets.
One of the proposals is to allow closed-ended funds to list on public markets more easily. We expect this to prove a popular route for many retail investors, especially when they can often gain access at a discount to net asset values (NAV). While these instruments often have low liquidity, that is obviously less of a concern for investors with smaller investment sizes.
European client base
Europe-based retail investors have faced similar constraints. Asset management regulation in Europe has largely confined retail investors to products that have regular liquidity. The European Long-Term Investment Fund (ELTIF) structure was introduced in 2015
to facilitate a minimum investment as low as €10,000. Managers are also able to acquire passporting rights to market across Europe. However, the first version of the ELTIF had limited success given that it was perceived as too inflexible. European regulators have been toying with the idea of making changes to the ELTIF structure to make it easier for retail flows to enter the market. The most notable proposed changes would be to remove minimum investment and wealth limits, which would help open private investing to a much wider audience.
Banks and fintechs have been busy building out private market platforms
To facilitate capital raising from retail investors, private capital fund managers have sought to leverage the distribution networks of banks’ wealth management and private banking platforms. For instance, Blackrock has partnered with Credit Suisse to provide a series of private equity vehicles tailored to retail investors.
In many instances, fund managers remain reluctant to accept investments below $1mn given the associated administrative burden. However, fintech platforms that can help automate the client onboarding process and provide access to a range of investments simultaneously in one place are starting to gain traction. One of the key drawbacks to these platforms is that they lack the distribution networks of established bank networks. As a result, the amount of funds that they have been able to help allocate remains low compared with the wealth management industry. Nevertheless, they have been able to persuade several prominent fund managers to accept investment flows from their platforms.
In Europe for example, the Moonfare platform has helped retail investors allocate close to $2bn
to leading private equity managers. The minimum investment it accepts is as low as £50,000. The emergence of blockchain technology in recent years may contribute to retail investment flows into private markets. It could do this because tokenizing fund stakes holds promise for further driving down the administrative cost of market access for individual investors.
Sustained retail flows may further blur the lines between public and private markets
Over the longer term, sustained growth in retail investment flows may weigh on private equity returns. This would be due to the flow of additional funds increasing competition for deals and eroding the illiquidity premium inherent in private markets. In theory, this premium explains a large part of the expected outperformance of private equity over public equity markets. The infusion of retail investor flows into the asset class would bring more transparency, liquidity, and competition for deals. This is noteworthy, as these factors have the potential to erode returns over the long term, and ultimately confuse the distinction between public and private markets.