Private-markets access for retail investors is mostly good – but with caveats

[SINGAPORE] Allowing retail investors to allocate to private-market funds is surely a good thing. Higher returns are sorely needed for retirement portfolios.

But it warrants caution as well. The devil is in the details – in the policing of the funds’ marketing, disclosures and practices. And, there is the financial advisory process, which is crucial to a well-informed decision. Advisers would be giving recommendations on a complex asset with higher fees – which could be a potentially lucrative revenue stream. They must be held to a higher bar when advising on such assets.

On Mar 27, the Monetary Authority of Singapore (MAS) published a paper seeking feedback on a regulatory framework to allow private-market fund investments for retail investors. Access is currently limited to accredited investors, defined as those with net personal assets of more than S$2 million, or an annual income of S$300,000.

Singapore isn’t unique in restricting access to private assets; most other jurisdictions do so as well. Regulators believe that more investor protection is needed for retail investors, due to private assets’ illiquidity, lack of transparency on underlying holdings, conflicts of interest, infrequent valuations and higher leverage, among others.

But this is changing rapidly. The US Securities and Exchange Commission (SEC) last year green-lit the listing of private-market exchange-traded funds (ETFs). In February, State Street Global Advisors’ (SSGA) private credit ETF debuted on the New York Stock Exchange – but not without a hiccup, which I’ll get to later. Others with plans for retail access include BlackRock and the Capital Group.

Europe also rolled out the European Long-Term Investment Fund 2.0 (Eltif 2.0) framework last year to democratise access. Eltif 2.0 removed the minimum investment threshold of 10,000 euros (S$14,600) for private-market funds.

Why private markets for retail

Some factors underpin the intense interest in the retail market. One, the traditional balanced portfolio of stocks and bonds is increasingly seen as inadequate in providing diversification benefits, especially after 2022 when stocks and bonds fell in tandem thanks to the US Federal Reserve’s aggressive rate hikes. It is important, however, to note that while correlations between various types of private assets and public equity are positive, they are negative in relation to bonds, as M&G Investments explained in a paper. To enhance diversification, it said, investors would do better to reduce their public bonds exposure to invest in private funds, rather than reduce public equities.

Two, the need for enhanced, positive returns for long-term retirement portfolios is far greater among retail investors than the wealthy. Vanguard, for instance, modelled the impact of a 10, 20 and 30 per cent allocation to private equity (PE), carved out of the equity portion, relative to an all-public portfolio of 70 per cent stocks and 30 per cent bonds. It found that PE can generate significant outperformance, even when adjusted for relatively higher volatility in PE returns, thus raising investors’ chances of meeting a 6 per cent annual return target.

Three, private companies are staying private longer and listed firms are also choosing to privatise. Just last month, the Australian Securities & Investments Commission (Asic) published a discussion paper on the dynamics between public and private markets. Initial public offerings in the Australian stock market are currently the lowest they have been in a decade. As more companies seek debt and equity financing privately, it is important, said the regulator, to understand and adjust for “new or amplified side risks”.

In Australia, retail investors get access to private assets mainly indirectly through superannuation funds, where private-asset allocation ranges between zero and 38 per cent. But Asic noted that direct retail access is rising; some private funds have set their minimum investment at A$2,000 (S$1,687).

Four, it makes business sense for traditional managers to offer retail access to their private-capital funds. Compared with traditional funds, where fee compression is intense, private and alternative assets offer fatter fees and margins.

In Singapore, retail investors already participate indirectly in PE through the Astrea series of bonds offered by Azalea Asset Management. The firm has successfully structured diversified PE portfolios into a series of bonds listed on the Singapore Exchange. Accredited investors may also co-invest in PE funds through its Altrium platform.

MAS’ paper proposes two vehicles for retail access – a direct fund investing in private assets or a fund of funds (FoF), which provides exposure to multiple managers, strategies and assets. The framework allows for listed and unlisted structures.

It has proposed risk limits for both vehicles, as well as limits on concentration and leverage. Among others, MAS has proposed co-investment by the manager to ensure alignment of interests and skin in the game. It also seeks feedback on whether a minimum proportion of the funds should be held by “smart money” – accredited or institutional investors – which may provide “some form of quality check”.

For both structures it proposes a redemption window of at least once a year. Some evergreen or semi-liquid funds enable monthly or quarterly liquidity, subject to caps.

To be sure, allowing retail access won’t be trouble-free. In the US, the SEC seemed to belatedly wake up to some risks. A day after the SSGA private credit ETF listed, it raised concerns on three counts – on the fund’s name (which originally included SSGA’s partner Apollo Global Management) being misleading; liquidity risk management; and the fund’s ability to comply with valuation rules.

SSGA has removed Apollo from the ETF’s name. In compliance with SEC requirements, the SPDR SSGA Public & Private Credit ETF will also cap illiquid investments at 15 per cent. As at Mar 5, according to Morningstar, the allocation was modest at 5 per cent.

Caution warranted

As I see it, some aspects warrant caution among retail investors:

• Fees: Fees in direct private funds are far higher than for unit trusts, and FoFs add yet another layer of fees. The typical private-fund fee structure is an annual management fee of 1.5 to 2.5 per cent, plus a performance fee of 20 per cent subject to a hurdle rate. On the FoF level, the manager may charge 1 per cent a year, resulting in a double layer of fees. This significantly eats up returns. High fees may also incentivise managers to provide misleading information about performance. The SEC published a risk alert in 2022 on compliance issues among investment advisers who manage private funds. For instance, it found that the advisers provided inaccurate or misleading information about their track records, such as cherry-picking a particular fund in materials or using stale information that did not reflect fees and expenses.

• Liquidity: Even with a liquidity window, a fund may occasionally restrict redemptions. This happened between 2022 and 2023 to Blackstone Real Estate Income Trust (Breit) which allows redemptions of up to 5 per cent of net asset value quarterly to “prevent a liquidity mismatch”. But a surge of redemption requests in late 2022 forced it to temporarily restrict redemptions. The crunch was caused by Asian private clients hit by margin calls on other assets. Breit, which has chalked up strong returns historically, suffered collateral damage as clients sought to liquidate Breit holdings for margin calls.

• Advisory: Financial advisers must impress upon clients the need to commit to a long-term horizon if they are to reap the much-vaunted illiquidity premium. They must also take a portfolio approach to investors’ asset allocation. After all, as much as investors seek enhanced returns, a private-fund allocation is also a diversifier and not a concentrated bet. Ultimately the prudent allocation may be modest, unless an investor demonstrates enough assets to tide over liquidity needs.

• Potential conflicts of interest. This should not be ignored. Australia’s Asic pointed to SEC’s risk alert on private-capital funds. The SEC, it said, has consistently found that conflicts of interest were “inadequately managed in the operation of private investments”. “For some firms, this has resulted in large profits at the expense of investors.”