Why Everyone’s Talking About… Democratising Private Assets

Public assets are defined by being traded in public markets – the London Stock Exchange or Nasdaq for example. Companies raise money by issuing shares (equities) or bonds which are ‘listed’ on public markets where they can be bought and sold. Prices are freely available and, with thousands of buyers and sellers, investors can buy and sell rapidly at the prevailing market price.

By contrast, private assets are bought and sold outside of public exchanges. Private funds may be focused on equity (buying companies or stakes in companies) or debt (providing private loans to businesses). Funds typically specialise in a particular sector such as real estate or infrastructure. The realm of private investment is often characterised as ‘alternative’, in contrast to the ‘traditional’ assets of bonds and shares.

Traditionally, private funds have fixed investment horizons of between five and ten years, over which time they buy, develop and then sell their assets. These funds are ‘closed-ended’, meaning that after the initial fund raising no new money is raised. They are also not publicly traded so investors cannot sell their stake or get their money out of the fund until the end of the term, after the fund has sold or ‘liquidated’ its assets.

Many factors have helped drive the rise in private assets in recent years. The global financial crisis in 2008-9 was one of them: as banks retrenched, businesses began to look elsewhere for investment and borrowing. Many have found that private investment can deliver all the capital they need without the expense and complexity involved in ‘going public’.

From an investor’s perspective, the attraction of private assets stems from three things: diversification; new forms of income; and the potential for long-term value creation without the volatility of public markets.

What is more, private assets offer the potential for higher returns. Private equity, for example, typically outperforms public stock markets over the longer term and private assets, though not immune to the ups and downs of the economy, are not subject to the short-term ups and down of public markets.

Institutional investors, such as pension schemes and insurance companies, have been increasing their investments in private assets over recent years, recognising that these assets provide an opportunity to diversify, while achieving capital security and income, which has become more elusive in public markets.

In the past, a typical institution only held shares and bonds traded on public markets. Today, most invest in private markets too, allocating as much as 20% of their total in these types of assets.

Indeed, our research found many institutions expect to increase their investment in private equity, private debt and real estate over the coming years² . And, where big investment firms have led, private investors are following – the democratisation of private markets is the next phase of this broadening of private asset investment.

The same motivations apply for retail investors as for institutions: diversification, the opportunity for higher returns and longer-term investment horizons.

A crucial factor in opening private markets to retail investors is the attitude of government and regulators. In recent years, private asset investment has been highly significant in many areas of the economy from digital technology to energy, where private investment is playing a significant role in renewables.

Private asset investment will play a significant role in the transition to a more climate-friendly economy, too. It has been estimated that $4 trillion will need to be invested every year between now and 2030 for the world to hit the 2050 net zero carbon emission target³.

The direction of travel among industry participants suggests the opportunity is there for the taking. For example, a report from PwC finds the majority of Limited Partners (LPs) and General Partners (GPs) are shifting towards an ‘ESG or nothing’ investment philosophy, with over three quarters planning to cease investing in or promoting non-ESG private market products by the end of 2025⁴.

And the long-term investment required to transition to a sustainable economy is well-suited to the private asset investment model. Its longer-term horizons enable it to invest without the market volatility that can encourage short-termism in public markets. Governments and regulators are increasingly recognising that much greater investment technology and sustainability is essential both for future growth and to meet climate targets.

A key example of regulatory change is the European Long-Term Investment Fund (ELTIF) regulation. In its current form, ELTIF places restrictions on retail investors' access to private assets with the aim of ensuring only professional or sophisticated investors take part. ELTIF 2.0, the updated version that comes into effect in 2024, will significantly relax these rules. The expectation is that private equity, private debt and private real estate funds will then be open to a far wider swathe of retail investors.

The ELTIF changes apply across all EU markets but are also indicative of the shifting approach to regulation elsewhere, including in the UK where authorities are consulting on their own plans to relax controls on retail investors’ access to private asset investment.

Liquidity is perhaps the greatest challenge. By their nature, private asset markets will always be less liquid than public markets. Locking up money for an extended period is not a familiar process for most retail investors, even more so when the returns are hard to quantify until the assets are sold.

Indeed, regulators are concerned that private assets have links to other parts of the financial sector that only become apparent at times of market stress. The chair of the UK’s Financial Conduct Authority has called for greater disclosure, saying a shvortage of data makes it hard for regulators to monitor a “cocktail” of risks in private markets such as hidden leverage and liquidity stresses⁵.

Yet managers of private assets are already considering ways to mitigate this lack of liquidity. The model of fixed-term, closed-end private equity funds is evolving, with indefinite-term funds that allow more flexibility and the potential for open-ended private equity funds that will allow investors to trade in and out of the fund at will.

As the market continues to develop, other new models are likely to emerge that aim to blend the long-term approach of private assets investing with some of the liquidity advantages that many retail investors want.

Transparency will be a further challenge. Private assets managers often provide investors with just as much information on their companies as would be available for a publicly-quoted stock. But there will be issues of scale and distribution – keeping a few score millionaires or institutional investors informed about their private equity funds’ investments is not the same task as providing information to thousands of retail investors.

None of these issues are insurmountable, of course – particularly when the interest in ‘democratisation’ is shared by investors, private funds and regulators. Yet, whatever solutions emerge, private assets will not be suitable for all investors. Those with shorter investment horizons, or those who want or need access to their capital in cash will not (and should not) be drawn into private asset investment.

For many, however, the opening of this space will bring new opportunities for diversification, new models for risk and return and even a greater sense of engagement and ownership with their investments.