When retail investors ride into the private equity universe

For the investing public, it would seem that a vehicle like a SPAC is a ticket to ride with the big boys of private equity. And indeed, the opportunity to jump on board what has been called the "poor man's private equity" has proved hard to resist. Special purpose acquisition companies (SPACs) have seen raging popularity in the past year, with record volume of issuances and prominent mergers taking place in the United States. The structure gives average investors a channel to invest alongside established sponsors in novel opportunities that can potentially provide outsized returns. Other products allowing some exposure to private markets have already been available in Singapore. And it's not hard to see why retail investors might seek out non-traditional vehicles for better returns.

Private equity (PE) has generally outperformed public markets over the long term. Over a 25-year period, a Cambridge Associates index tracking PE funds saw 13.2 per cent annual returns, higher than the modified public market equivalent annual returns from the S&P 500 and MSCI World indices of 8.7 and 6.6 per cent respectively.

But PE is usually accessible only to institutions and high net worth clients who can afford high investment minimums and long periods of illiquidity. The lock-in period is typically around 10 years, and can stretch as long as 15 years.

Max Loh, EY Asean IPO leader, observes that there has been a lot of thought going towards democratising or equalising access to the private market, with questions being raised: "Is it fair that only accredited investors or institutional investors or high net worth individuals can access private markets and benefit from them?"

Margaret Lui, chief executive of Azalea Investment Management which is behind the Astrea private equity bonds, says PE is becoming more mainstream, as companies stay private longer, with a decline in the number of listed companies on exchanges.

"Increasingly, it is also another asset class - not just an alternative asset class - that one should look at in an entire portfolio," she says.

Still, retail investors are mostly unable to buy directly into PE funds, and some may opt for hybrids to meet their investment goals.

SPAC-tacular potential?

The latest product to come to the fore are SPACs. The listed cash shells give retail investors an opportunity to join established sponsors who seek to acquire hot companies, much like buyout funds.

While the listing structure has existed for decades, SPACs surged into prominence last year, with Bloomberg data showing over 500 SPACs going public in the US, raising around US$170 billion in the last 12 months.

Investors buy into a SPAC's initial public offering (IPO) without knowing what the resulting company would be - essentially giving sponsors a "blank cheque". Sponsors have a fixed timeline to carry out a suitable acquisition - known as a de-SPAC - or return the monies to investors with interest.

Tham Tuck Seng, capital markets leader at PwC Singapore, says a key difference between SPACs and private vehicles is liquidity and transparency of information, given that SPACs are publicly traded from the outset, and de-SPAC transactions would also be subject to disclosures.

This could make it more conducive for retail participation.

Robson Lee, partner at global law firm Gibson, Dunn & Crutcher says: "It will give that flutter of interest to most retail investors... especially if the SPAC's sponsors go out with the aim of going into some high-tech companies."

Already, investors here are perking up. Local forum HardwareZone has a thread on SPACs that is over 40 pages long, with participants mainly discussing US-listed vehicles.

One user opines that SPACs would allow for retail investors to invest in IPOs at early stages, with an opportunity to make "40 to 50 per cent profit" with some downside protection.

In reality, when homegrown tech firm Grab announced it was going public via a SPAC merger with Altimeter Growth Corp last month, the SPAC's shares rose to close at US$15.33 on the same day, representing healthy gains for investors that managed to buy the units for US$10 at its IPO. However, the shares have since drifted slightly lower.

Another attraction of SPACs is the opportunity to tap on the experience of established sponsors. PE giants such as KKR, Warburg Pincus and Apollo Global Management, and veteran investors including Bill Ackman have raised their own SPACs.

EY's Mr Loh says: "I think a lot of the people feel that it has strong appeal, because when you have a really smart person doing investment decisions for you, it makes sense, right?"

However, he adds that investors would need to ensure if the sponsors were indeed of high quality as they are making a bet on them.

Mixed track record, hidden costs

For investors tempted to take a chance on SPACs, the track record of the structure should be a key consideration. Gibson Dunn's Mr Lee emphasises that investors need to question how professionally experienced the sponsors are in terms of carrying out large acquisitions, such as doing the proper due diligence, and valuation on target companies.

With sportstars and ex-politicians getting in the fray, the US securities regulator has warned against investing in SPACs based solely on celebrity involvement.

The listing structure can also be more expensive for investors due to dilution, Mr Tham points out.

SPACs typically compensate sponsors with 20 per cent of the shares for a nominal sum, known as the "promote". They also provide warrants to investors, which can be retained, even if an investor redeems their initial capital, essentially for free.

Sebastien Canderle, a private equity and venture capital adviser writing in the CFA Institute blog, says that generally around three-quarters of SPAC shareholders tender their stock for redemption upon a merger, with most being institutions.

"That leaves smaller investors exposed to what is often lacklustre post-merger performance."

Sponsors lose very little if post-merger performance disappoints, he adds. "Most of the risk of failure sits with public shareholders."

As a Wall Street Journal headline spelled out earlier this week: "SPAC insiders can make millions even when the company they take public struggles". (The article details how many individual investors can end up taking losses on SPACs, while insiders benefit from discount stakes).

While there have been success stories from the likes of DraftKings and Virgin Galactic, an academic study by Stanford and New York University of the 47 SPACs that merged between January 2019 and June 2020 found the median returns three months after the SPACs merged was -14.5 per cent.

Market participants also point out that SPACs have key features that differentiate them from PE funds.

Mr Canderle observed that PE and VC funds are diversified portfolios, while SPACs are ordinarily single asset instruments.

Mr Loh also notes that SPACs may be more similar to regular IPOs than PE, as there will be a specific target, just that the process involves raising funds first in a public company before identifying a target.

Although investors may like SPACs for the downside protection - they can redeem their capital if they dislike deals - part of this depends on when they actually buy a SPAC's units.

Observers note that retail investors generally do not enter into SPACs at their IPO - which are mostly taken up by hedge funds. Rather, they buy into SPACs after they are already publicly trading and may pay above the IPO price, with no protection on excess paid.

The Singapore Exchange (SGX) in March launched a consultation on SPACs with proposed tweaks to the structure such as limiting redemptions to dissenting shareholders, and requiring minimum sponsor equity participation and shareholding moratorium to better align interest.

Securities Investors Association (Singapore) (SIAS) founder and chief executive officer David Gerald said proposals in Singapore for prospectus-level disclosures, and having due diligence done at the acquisition stage, would make investors here better off than those looking to US-listed SPACs, which are currently subject to fewer requirements.

Existing channels

For retail investors in Singapore wanting exposure to private markets, other channels allowing some access are already available.

Temasek-backed Azalea Investment Management launched in 2018 Singapore's first retail bonds with cash flows backed by investments in a portfolio of PE funds under the Astrea line, with two subsequent offerings since.

Azalea's Ms Lui says the company took a "phased approach" to introducing private equity to the masses, knowing that the market needs to be educated and become familiar with this asset class, while current regulatory environment does not allow for the regular PE to be offered to retail.

While stable fixed-income instruments may not serve up the outsized returns that PE can bring, they have certain structural safeguards, such as reserves accounts and a credit facility, to mitigate risks.

Introducing investment-grade rated and listed PE-backed bonds allows the company to gradually bring PE to retail investors, Ms Lui says.

There has been clear demand from the investing public. The retail tranches of the bonds - with coupons of between 3 per cent and 4.35 per cent - have been between 3.1 and 7.4 times subscribed.

"Over time, retail investors and other stakeholders can become more comfortable with the risks and return of PE so that regulations will allow beyond the investment-grade tranches including the equity level to be available to retail investors," she adds.

Azalea has an equity product under the Altrium line, which is a fund-of-funds that is only available to accredited investors currently, and Ms Lui says it helps mass affluent investors access reputable PE managers that they might have been unable to tap into on their own.

"It is about offering more investment options to Singaporeans," she adds.

Since late 2019, private markets platform CapBridge has also allowed those who meet knowledge requirements to participate on its syndication platform and invest in late-stage growth companies.

The platform, which counts SGX among its shareholders, has placed out over a dozen investments since it began actively syndicating primary fund-raising opportunities to individual investors. These include pre-IPO unicorns, growth companies, and PE/VC funds.

"Should the products available to you be based on your wealth or based on your knowledge?" asks Johnson Chen, founder and chief executive of CapBridge.

While not all products may be suitable, Mr Chen says: "I would argue that the well-established names, with good track record - some of these things can be made available to retail."

To manage risks, CapBridge requires retail investors to be certified sophisticated by passing a customer knowledge assessment. They should also typically co-invest alongside institutional investors who are leading the deals, and carrying out the necessary due diligence.

Retail investors should also have risk mitigation limits such as not being able to invest more than 10 per cent of their net assets on the platform.

"We always start by saying private markets are clearly higher risk than public - higher risk, but also higher potential returns," Mr Chen says. "So if you want to do that, then this is how we can step by step do it for you."

Even so, CapBridge says retail clients are not their key focus, and retail participation since launch has been limited, as the firm has been taking a prudent approach.

One possible factor holding back some retail participants may be the minimum investment size of US$50,000 needed currently. Also, retail investors cannot trade on CapBridge's affiliate 1exchange, and would need a liquidity event such as a public listing to exit their positions.

Still, Mr Chen says the firm would consider breaking down investments to smaller ticket sizes - even to as low as US$1,000 - if there are investment opportunities with suitable track record and backing.

"We would break this down into smaller chunks, and offer it to the retail, as part of a good way for these retail to allow them to balance their own portfolio".

Safeguards and education

Although retail investors have more options today, some experts believe full access to PE may not be appropriate.

Mr Gerald of SIAS says private equity is generally more opaque, which may make it less suited for the retail market at large.

EY's Mr Loh adds that there are also other factors involved such as investor understanding of fees and process involved in PE investing.

He believes that more hybrid products, which provide PE exposure, while managing some risks, could be the direction for the markets going forward.

"It must be the objective of regulators to make sure that retail investors are protected," he says.

PwC's Mr Tham says having different products such as private platforms, PE bonds and SPACs cater to different investors and adds to the vibrancy of the capital markets ecosystem, especially in Singapore.

While some protection is useful, he adds that there should not be so many safeguards that would create an uncompetitive situation.

All investments, as Azalea's Ms Lui puts it, from bonds to listed or unlisted equity, come with risk.

While PE is more illiquid than listed shares and bonds, Ms Lui notes that this is not necessarily a bad thing as it can protect investors from buying high and selling low and gives the professional fund manager time to allow the portfolio to be nurtured and recover from any market or macroeconomic disruptions.

"Every investor must understand the risks they are taking," she says. "The best protection is investor education."

Having additional protective safeguards may result in returns being compromised.

Experts also emphasised the importance of investors taking responsibility to understand products, and assess if they can bear the consequences if things go wrong. While emerging companies may potentially offer higher returns, observers note they are subject to future uncertainties, as some may not yet be profitable.

SIAS's Mr Gerald urges investors to consider the risks - and not just the returns - and to only invest in things that they understand. "If you are inclined to invest - you know about it, you like the business - okay, put some money in it and see," he says. "Don't put all your money in it."