How democratization of private investing is shaping investor experience

Tim Flannery
Tim Flannery
September 7, 2023

While the alternatives markets haven’t been closed off entirely to individual investors, entry has historically been limited to the highest end of the wealth scale due to a number of structural barriers—regulation, economics, and liquidity constraints—that were the result of securities acts from the 1930s and 1940s.

But individual investors aren’t a monolith. They’re typically divided into tiers based on wealth: ultra-high-net-worth individuals (those with more than $30 million in investable assets), very-high-net-worth (more than $5 million), and high-net-worth ($1 million to $5 million). Below these tiers is the mass affluent segment: individuals with meaningful portfolios and investable assets of less than $1 million. 

Private equity already successfully reaches individuals at the highest end of the wealth scale ($100 million to $500 million-plus) because they’re large enough to be targeted and deemed sufficiently sophisticated to invest. Meanwhile, the mass affluent segment at the bottom is the most shielded by regulation. It’s those in the middle that are garnering the most attention (and expressing greater interest). 

Retail investors are fundamentally changing their approach to asset allocation to diversify their portfolios and take advantage of the higher returns in private markets. But just because some firms are actively pursuing this strategy doesn’t mean everyone should. But every firm manager should at least be asking the question: is retail right for me.

Institutional investors lead while retail investors follow

Financial products available to the few tend to find their way to the many. Not too long ago, investors needed to know a broker to buy stocks. Now anyone can create an account with Schwab, E*TRADE, or Robinhood and trade derivatives on their phone. You don’t need a contact at a broker-dealer to buy a basket of stocks. You pick up whatever ETF you’d like.  

Historically, the fact that a majority of private equity funds have outperformed stocks. Of course individual investors view alternatives as an attractive asset class for outsized returns and portfolio diversification benefits.

The attention is not unrequited: fund managers are making clear moves to tap into this new pool of funds. Blackstone sees potential to expand retail capital from $200 billion to $500 billion, KKR expects between 30% and 50% of new capital raised over the next few years to come from the private wealth channel, and Apollo seeks to raise $50 billion in retail capital cumulatively from 2022 through 2026. In our recent State of Fundraising report, 49% of fund managers we surveyed expect more retail investor participation. 

But with individual investors comes new challenges

The retail market brings with it new risks, expectations, and operational challenges. Retail investors have different expectations around liquidity. The traditional limited partnership structures that fund managers are used to may not be the most appropriate vehicle. Some GPs have explored the use of private business development companies, interval funds, and real estate investment trusts that permit greater access to retail investors and more regular and predictable liquidity. But even with that, fund managers can run into redemption issues like Blackstone’s REIT discovered earlier this year

It’s also changing the strategy of distribution partners, like wealth management firms. . Research PwC carried out among HNW individuals in the US found that many are reconsidering their wealth management relationships as they seek access to an increased variety among products and services—including private markets. 

You have to meet the new investor where they’re comfortable: digitally

The unprecedented transfer of wealth from baby boomers to millennials that is likely to occur in the coming years—some US$68 trillion by 2030—will likely heighten the calls for tech-enabled services, as millennials are the first truly digital-native generation.

Besides going direct, investors have more digital pathways into private funds than ever. Moonfare and iCapital have built platforms aimed at either financial advisers or directly at individuals that offer low-cost access to a wide range of alternative products.

Moonfare is a fast-growing direct-to-consumer platform based in Berlin that offers self-certified investors access to PE funds by pooling individual investments. iCapital is a much larger firm based in New York that uses a similar pooling model to aggregate investments in buyouts and other types of alternative investments.

Platforms like Securitize are offering access to alternative assets through blockchain-based smart contracts, with KKR and Hamilton Lane launching tokenized fund structures on the platform with minimums as low as $10,000. These experimental models look to cut administrative costs and improve economics for GPs, while offering a retail-like user experience. They’re another avenue for GPs to address liquidity challenges as well. So far, these initiatives are experiments. But those experiments are indicative of firms’ interest to build faster, more efficient bridges to individual investors.

Individual investors don’t have brand awareness let alone brand allegiance

Private equity’s traditional focus on building lasting relationships with a relatively small cohort of large institutional investors means the industry has done little historically to create the brand and marketing required to effectively reach individuals.

HNWIs rarely understand how the industry works let alone who the major players are. According to a survey by Bain, ask a wealthy person who the big names in private equity are and “I don’t know” rises to the top, followed by large financial institutions such as Fidelity and Charles Schwab that barely have any presence in alternatives.

This means customers, especially younger ones, won’t come to you. GPs need to reach them where they are, find what influences their choices, and learn how to establish brand presence and relevance. 

Your firm’s unique thesis and approach is how you got existing investors to allocate capital to you in the first place. But chasing retail requires that you change your communication strategy to highlight what makes you different to a broader audience. Each message in every channel slowly builds your brand and authority. None of this is in a vacuum: you still need great returns. But great returns may not be enough to build the recognition required for a retail strategy.

Individual investor volumes force other operational changes

Retail investors may contribute 10% of your capital but require the majority of your time. The prospecting requirements, lack of investment experience, and expectations around communications needs may require a different operating model than most funds have in place today. It’s time to re-evaluate every touch point that you have with investors with that in mind. 

First, how are you going to find these LPs? Do you need to develop relationships with RIAs or the wirehouses? Do you want to use placement agents to target individuals in different geographies? In that case, you’re relying on others to pitch on your behalf. 

Once you’ve found and convinced those individuals to invest, life doesn’t get easier. You need to get subscription documents executed, KYC/AML checks completed, collect capital calls, and handle questions all along the way. The good news is that firms like ours are coming along to automate many of these manual, time-intensive tasks—such as investor onboarding—to allow firms to scale without a significant increase in cost. The way you service investors determines whether or not you’ll keep them. 

A survey by EY found 63% of fund managers reported that they’re deploying new technology to mitigate margin erosion. Investments in technology are:

  1. Improving their capabilities
  2. Reducing employees’ time on administrative tasks
  3. And leading to better investor outcomes

The rise of retail in private markets is inevitable. 

Alternatives have grown from X to Y over the past Z years and are projected to grow to A by B. This growth has occurred despite the past accessibility issues for individual investors because of regulatory, operational, and technology challenges.  But the paradigm is changing, which means that growth will no longer be throttled. 

But it also won’t be without challenges. The funds that have already jumped in are still exploring what works in retail, and there’s a lot of learning left. But they are moving quickly, guided by the conviction that they will need a new and very large pool of capital to fund their growth ambitions. That is forcing the issue for the rest of the industry. Fund managers don’t need to embrace retail. But they do need to examine their position in a shifting environment.

Talk to one of our team about how you can improve your investor experience with Passthrough.


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