The risky world of private assets opens up to retail investors

The pause is robbing private-market investors—typically deep-pocketed institutions, or uber-rich individuals—of a big payout. It is also robbing smaller investors of a chance to invest in some of the world’s most successful companies, such as Stripe, a payments firm, and Elon Musk’s SpaceX. That is making an existing problem worse. Measured against the value of all stocks, the monthly value of equity issued on stockmarkets globally has crumbled in recent years (see chart). That has made private markets the most exciting corner of the investing universe, with trillions of dollars flowing into private equity (PE), venture capital and private debt. Private assets under management, which also include infrastructure and property funds, have surged to $24trn, from $10trn a decade ago.

Now private-markets firms are dreaming of getting even bigger—by luring in the investing masses. Marc Rowan, who runs Apollo, a private-credit giant, says the savings of ordinary Americans are his company’s biggest opportunity. Larry Fink, the boss of BlackRock, the world’s largest asset manager, focused his latest missive to shareholders on the subject. New products aimed at a broader cohort of investors are multiplying. This “democratisation" could benefit millions of investors. But, because private assets are less liquid, more opaque and much less regulated than their listed peers, it also creates new risks.

There are good reasons why private assets have long been the preserve of a select few. At its inception, the typical private-equity fund secures commitments from a small club of pension schemes, endowments and other institutions to provide a sum of capital, usually in the tens of millions of dollars. The money is then called on in instalments whenever the fund’s manager finds a company to buy. At the end of the fund’s life, which can extend to a decade or more, the manager sells or floats the company before returning money to investors.

Such conditions are a poor fit for the mass market. Smaller investors are less likely to tolerate the unpredictability of cashflows coming out and back. They are also ill-equipped to handle the mountains of paperwork managers would send their way. Those wanting their money back before the end of the fund’s life—in the event of a stockmarket correction, for instance—cannot easily sell their stakes. Enforcing capital calls on legions of individuals would also be impractical.

But pioneering products have arrived. In 2017 Blackstone’s Real Estate Income Trust (BREIT) was launched to invest in property, which is typically unlisted. The fund has a minimum buy-in of $2,500, a “perpetual" lifespan and monthly windows during which investors can sell out. BREIT limits the total amount of shares it will repurchase from investors to 5% of its net asset value (NAV) in any quarter. It has boomed in size, to a NAV of $54bn.

The Blackstone Private Credit Fund (BCRED), launched in 2021, has done the same for private debt. It is the largest of a growing array of vehicles, dubbed business development companies (BDCs), offering retail investors exposure to private investments. On April 29th Capital Group, an investment firm, and KKR, a private-markets giant, jointly launched two funds blending public and private assets. The vehicles will have a minimum investment of $1,000 and annual fees below 0.9%, much lower than most private funds. Such products “only scratch the surface of what we can offer", say the sponsors. Assets held by BDCs have more than tripled over the past five years, to $438bn at the end of December.

Barbarians at the garden gate

Whether such products fly or flop depends on their ability to solve three problems. First is the murky nature of the assets themselves. Public data on private markets are scarce. Whatever are available are hard to interpret. Firms are often accused of massaging the valuations of their holdings to flatter returns. The measures they use are hard to compare with public-market benchmarks. Sporadic reporting allows them to smooth out bad periods.

There has been some progress. Last year MSCI, an index provider, unveiled private-market benchmarks that crunch the cashflow data for 14,000 funds since their inception. The new benchmarks also track funds’ performance using figures gathered from investors. These should allow funds to be more rigorously compared with other offerings.

Another barrier to democratisation is law and regulation. Private-markets firms eye America’s vast retirement system. Huge defined-benefit pension schemes, such as the California Public Employees’ Retirement System (CalPERS), have invested heavily in private markets for decades. But individually managed retirement accounts, and defined-contribution 401(k) schemes run by employers, which together hold $26trn in assets, have almost no exposure to private markets. A law from 1974, which spells out pension-plan providers’ fiduciary duties, makes it possible they could be sued if they invest in private assets because of their lower liquidity and the high fees charged by fund managers.

Here too, change may come soon. Daniel Aronowitz, Mr Trump’s nominee to run the Employee Benefits Security Administration at the Department of Labour, has complained about frivolous lawsuits against corporate-pension providers. In 2023 Mr Aronowitz called some criticisms of pe in pension portfolios “naive and uninformed," noting that exposure could offer both diversification and returns. With narrow Republican majorities in both houses of Congress, private-fund managers are hopeful that they will finally get their foot in the door.

The most fundamental difficulty is that private assets are largely illiquid. Whereas stocks and bonds are traded all day long, stakes in private funds change hands only very rarely. Would-be buyers are scarce; working out a price is hard. Transactions, when they do happen, are not public so history can hardly serve as a guide. All this means retail investors cannot simply pile in and out of private assets at will, as they might with other parts of their portfolios.

This is a problem new products are finding hard to solve. In November 2022, amid market ructions, many investors in BREIT tried to withdraw their money. The trust could return only 43% of the capital it was asked for; more than a year later it was still limiting withdrawals. Private-equity products could face even bigger liquidity problems, notes Jerry Pascucci of UBS, a bank. Whereas credit and property generate steady streams of cash, equity funds must keep a hefty cash balance or draw on loans, both of which reduce returns, if they are to permit regular withdrawals.

To offer punters more liquidity, a few firms have started to offer exchange-traded funds (ETFs) containing private assets. The first was launched jointly in February by Apollo and State Street Global Advisers, a giant ETF provider, with the ticker PRIV. To ensure the minute-by-minute liquidity an ETF requires, however, the fund’s private holdings will normally be limited to 35% of its total assets. Its largest holdings currently are mortgage-backed securities and Treasury bonds, which are very liquid.

The idea of a liquid vehicle for private assets comes with its own problems. When investors want to transact shares in an ETF, the fund manager must buy or sell shares in the underlying assets to match the changing exposure. Were investors to want to sell their stakes in large volumes, the ETF managers may struggle to find buyers for the illiquid equity and debt inside them. That could cause the funds to seize up. The Securities and Exchange Commission has expressed concerns that priv may not be sufficiently liquid and could struggle to comply with valuation rules. Its warnings appear to have deterred rival firms from launching copycat products.

For a long time the democratisation of private markets, though much talked about, remained elusive. Now at last the winds of financial innovation and regulatory change are blowing in the right direction. But as they entice more retail savers, private-fund managers will come under greater scrutiny. Working around the illiquidity of the asset class is hard, and it may even be dangerous to try. In the event that new products disappoint or trap people’s savings, a backlash could ensue. The potential prize is huge. But catering for the investing masses is a risky business, too.

For more expert analysis of the biggest stories in economics, finance and markets, sign up to Money Talks, our weekly subscriber-only newsletter.