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Historically, private equity (PE) has catered primarily to institutional investors, such as pension funds, endowments, and accredited individuals—including high-net-worth individuals and banks. This group is generally considered financially savvy, capable of navigating the risks and illiquidity associated with long-term private market investments.
Recently, a significant initiative by the Securities and Exchange Commission aims to expand the definition of an “accredited investor,” thereby paving the way for retail investors to enter the realm of private equity.
This development raises critical questions: Are retail investors well-equipped to understand the intricacies and risks associated with private equity investments? Are they aware that they might be primarily filling capacity for PE firms, often receiving fewer appealing opportunities compared to institutional counterparts?
A surge in interest for private markets
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The allure of private equity is hard to ignore. A recent report by Bain & Company forecasts that private market assets will grow at a rate surpassing public assets, possibly reaching between $60 trillion and $65 trillion by 2032. This potential for explosive growth has ignited interest among retail investors, particularly in light of the market volatility experienced in 2022, which many see as an opportunity for better diversification and returns.
However, this push towards democratizing private equity carries important caveats.
Retail investors are often viewed as filling capacity for PE firms, providing capital that institutional investors might overlook. Offerings targeted at these investors, frequently through structures like interval funds, resemble traditional mutual funds but come with limited liquidity—typically allowing withdrawals only quarterly and sometimes imposing caps or suspending them altogether. While these products can extend access to private markets, they often lack the exclusivity and premium opportunities available to institutional investors.
The complexity of private equity can be daunting for retail investors. Unlike public markets, where transparency is more common, private equity often functions within a less transparent framework, with no mandatory disclosure of financials or operational details. This opacity can leave retail investors in uncertain territory regarding the true risks and performance of their investments.
Furthermore, the illiquid nature of these investments means that individuals may need to wait years to exit without guaranteed returns. What happens if a retail investor needs to sell their stake during a market downturn? The options for doing so are often severely limited, with potentially dire consequences.
Managing FOMO
The fear of missing out (FOMO) can be a powerful motivator for investing in alternative assets like private equity, but it can also lead to hasty decisions. Retail investors may not grasp the full implications of higher fees, longer lock-up periods, and restricted liquidity associated with such investments. They might underestimate the risks present in a sector that often thrives on exclusivity and expertise.
Institutional investors typically have the resources to conduct thorough analyses and negotiate favorable terms, while retail investors may depend on intermediaries who might lack their interests at heart. This can lead to retail investors being presented with subpar opportunities, such as co-investments or funds-of-funds, which may yield lower returns than direct investments in top-tier private equity funds.
The limited regulatory oversight in the private equity sphere forces retail investors to depend heavily on their judgment and the reputation of the firms they choose to invest in. For those without significant expertise or experience, this reliance can be precarious in an industry known for its complexity and lack of transparency.
Proceeding with caution
The increasing accessibility of private equity represents a double-edged sword. While it opens up an asset class that was once reserved for the affluent and institutional players, it simultaneously subjects retail investors to substantial risks and complications. It’s important to understand that private equity is not a universal solution; it demands patience, insight, and a high tolerance for risk—qualities that might not align with every retail investor’s profile or goals.
As enthusiasm for private markets continues to rise, maintaining a healthy degree of skepticism is vital. Retail investors should evaluate whether they are fully prepared for the complexities that accompany private equity investments. Are they ready to handle the illiquidity, opacity, and likelihood of lower-tier options? Or are they merely enticed by the prospect of higher returns without comprehending the associated risks?
How the democratization of private equity unfolds remains to be seen. In the interim, retail investors would be wise to approach these opportunities with caution, seeking guidance from trusted financial advisors while carefully weighing potential rewards against inherent risks.
Jonathan Foster is president and CEO at Angeles Wealth Management.
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