Private equity wants a piece of your retirement savings
AMID the roster of banks and brokerages helping KKR raise money for some of its newest infrastructure investments, two names stand out: Fidelity and Charles Schwab.
Both are known for serving individuals, not the pension funds and endowments that typically invest in multibillion-dollar investment partnerships such as KKR’s. But money from these big institutions is drying up because many of them gorged on private equity to chase returns when interest rates were near zero, and now they are too heavily invested in the asset class.
Individual investors, by contrast, represent a deep reservoir of untapped riches. They had an estimated US$178 trillion worldwide as at 2020 – and just 1 per cent of that was devoted to alternative assets, according to a September KKR investor presentation. Fidelity and Schwab provide firms such as KKR entree to those on the lowest rung of the private wealth sector: the so-called mass affluent.
The brokerages offer access to individual retirement accounts (IRAs) at a time when retiring baby boomers are shifting their nest eggs into IRAs from employer-sponsored savings accounts such as 401(k)s. That is a promising trend for hedge funds and private equity firms because IRAs have far more leeway to invest in alternative assets.
“The amount of money that is in IRAs is the largest pool of liquid capital on Earth,” said David Himmelreich, a senior vice-president at Wealth Enhancement Group. It is getting more and more important to private equity firms, he said.
Schwab and Fidelity are listed alongside Morgan Stanley Smith Barney and Rockefeller Financial in regulatory filings as potentially receiving compensation through a private placement by KKR Infrastructure Conglomerate.
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KKR, Schwab and Fidelity declined to comment on the entity, one of two flagships created to raise money from rich individuals. The other is KKR Private Equity Conglomerate.
The two conglomerates have raised more than US$2 billion combined since May, according to Kevin Gannon, chief executive officer of Robert A Stanger & Co, an investment bank whose specialties include alternatives such as non-listed real estate investment trusts and business development companies.
Accredited investors
While Schwab and Fidelity have spent decades courting the mass affluent – people with US$100,000 to US$1 million to invest – it is only recently that private equity firms such as New York-based KKR have sought to tap their savings.
The two conglomerates mark the first time that KKR has directly opened its infrastructure and private equity deals to accredited investors, a category that generally includes the mass affluent. KKR plans to draw 30 per cent to 50 per cent of its new capital from the private wealth sector, up from about 15 per cent now, chief financial officer Robert Lewin said in a February conference call.
The effort will get a boost as investors increasingly shift money from 401(k) plans – an arena that private equity has lobbied to enter with only limited success – into IRAs.
Savers in the United States rolled almost US$780 billion into IRAs from 401(k) accounts and other retirement plans last year, according to calculations by Cerulli Associates, which forecasts the annual figure will reach US$900 billion by 2028. Rollovers accounted for most of the US$1.7 trillion net increase in IRA assets between 2017 and 2022, said Cerulli analyst Elizabeth Chiffer.
The trend stems from the “baby-boomer migration into retirement”, she said. It makes more money available to invest in private funds because the rules governing IRAs are less restrictive than those that govern employer-sponsored retirement plans.
People changing jobs mid-career also account for some of the rollovers.
‘Really scary’
Financial advisers are key to gaining access to the billions of dollars flowing into IRAs. People at or near retirement age typically delegate investment decisions concerning their IRAs to these advisers instead of handling the portfolios on their own.
“We are seeing more and more people come in and they will say, ‘I have managed my money for years and years and I was pretty satisfied with it’,” said Malcolm Makin, president of Professional Planning Group, a registered investment adviser – or RIA. “But things are getting really scary out there now, and I want to be sure it’s done right.”
Schwab and Fidelity serve as gatekeepers to RIAs, who oversee a large portion of the US$9.7 trillion now sitting in IRAs.
The two brokerages provide custodial services to most RIAs in the US and also manage platforms that allow alternative-asset managers to make their funds available to these advisers.
Schwab and Fidelity are paid fees for providing such access, which is partly why they are listed as receiving compensation through KKR Infrastructure’s private offering, according to people familiar with the matter. The brokerages will also be paid for administrative services, the people said.
Raising money through independent RIAs requires a lot more work than going to the private banks that cater to high-net-worth investors, said Gary Ribe, chief investment officer of Accretive Wealth Partners in Parsippany, New Jersey. That is because the money managers must contact each individual RIA to seek capital.
“The RIA community is tough to crack into, because when you have met one, you have met only one,” Ribe said. “But if you go to a large private bank, it’s a lot easier to make big sales to multiple advisers.”
Trailblazer
KKR created the conglomerates during the past year with help from Rajib Chanda, a Simpson Thacher partner who, according to the law firm’s website, has been hailed as a “trailblazer” for his legal contribution to the “democratisation of access by ordinary investors to private market investments”.
The model they used resembles Warren Buffett’s Berkshire Hathaway.
The conglomerates were formed as operating companies rather than investment funds, meaning they are direct owners of actual businesses and hard assets – such as toll roads and airports – instead of securities and shares of other funds. They will directly co-invest in buyouts and infrastructure deals through joint ventures with the main private equity and infrastructure funds that KKR runs for institutional investors.
As operating companies, the conglomerates also qualify for exemptions from rules that would otherwise cap the amount of IRA money they can take in at 25 per cent of net assets. While this structure has been previously used by the likes of Brookfield Infrastructure Partners, whose shares are publicly traded, the major private equity firms are just now starting to adopt it. In June, Apollo Global Management filed documents for an infrastructure entity that is in many ways identical to KKR’s.
“The idea is to have products that people can access without having to meet very high net-worth requirements,” said Joshua Lichtenstein, a benefits partner at Ropes & Gray in New York, noting that he was commenting about a general trend rather than a specific offering. “Democratisation really means retail access.”
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