By Steve Blewitt who is presently a Fellow participating in the University of Chicago’s Leadership & Society Initiative.
Is the democratization of private markets good for individual investors?
In the past few years, in response to increased demand, a number of factors, including regulatory and technological changes, have opened up greater access to private assets for individuals. This phenomenon, commonly referred to as the “democratization of private markets,” offers significant potential benefits for individual investors, such as higher investment returns and improved diversification. However, the democratization of private markets also comes with some real risks, such as illiquidity, opacity in information, and high investment costs. Currently, there is an uneven playing field for individual investors striving to achieve their goals, so it’s essential to exercise caution when considering allocations to private markets.
This article explores how public markets have evolved to allow individuals to confidently invest in public equity and fixed income, and why a similar evolution is needed for private markets. Drawing on my 35 years of experience investing in private markets for a large financial institution and its clients, I see the need for structural changes that enable greater access, greater dissemination and standardization of information, and the development of a robust secondary market. Importantly, too, the democratization process requires individual investors to educate themselves about the significant differences between private and public securities and learn about the tools and techniques that institutional investors have used to successfully navigate the challenges of investing in private assets.
Public Markets Has Long History of Increasing Disclosure
Regulatory and technological changes combined with greater information and analytical tools have allowed individual investors to become significant participants in public markets.
Public market exchanges began forming in the early 17th century as municipalities and corporations sought to diversify and expand their sources of capital.¹ Since then, despite growth occurring in fits and starts, there has been an evolution marked by increased access and information. This evolution has allowed the size of global public exchanges to reach an estimated $231 trillion, with fixed income accounting for approximately 55% of the total ($130 trillion) and equities making up around 45% ($101 trillion).²
Requirements to publish financial data in accordance with specified standards helped to level the information gap for individual investors. During the last 90 years, basic financial data has been supplemented by significantly greater disclosures by public companies as well as in-depth analysis by independent research firms and all forms of media. Generally speaking, access to timely, standardized, and independent information is now readily available to all investors for free or at a limited cost.
Milestones in the Evolution of Financial Information Accessibility:
Individuals Well-Equipped to Navigate Public Markets Landscape
Individual investors also have the information and experience to make savvy choices when it comes to institutionally managed public market funds.
Given the vast number of global public issuers and the rapid fluctuations in security prices tied to issuer-specific data or broader market trends, many individual investors have turned to the steady hands of mutual fund managers. They entrust these experts to actively navigate the complexities of stocks and bonds or opt for the simplicity of index funds, which track broad well-defined indices like the S&P 500. According to the Investment Company Institute (ICI), approximately 52% of households in the United States owned mutual funds in 2022,⁶ with mutual funds holding about 25% of U.S. stocks and bonds.⁷
As individual investors have increasingly relied on professional fund managers to invest their savings and wealth, tracking performance, fees, etc. of those managers has also become a daunting task. But, as mutual funds rose in prominence, regulations changed, and firms such as Morningstar and Lipper began to categorize and rate funds with standardized criteria to provide easily understood tools to assist individual investors in selecting managers. Some of the basic information that these firms develop is published for free, and more in-depth research and analysis is available for a fee to individual investors.
Growth of Private Markets More Recent but Still Substantial
Over the last 40+ years, while investor interest in public market securities and mutual funds has grown substantially, investor interest in private markets has also had robust growth. Although the modern private equity industry is believed to have started shortly after World War II, significant capital formation did not start until the late 1970s and early 1980s. Some of the factors that led to this change were the broad economic conditions of the period (such as high inflation and high interest rates), a reduction in the long-term capital gains tax rate in the U.S., and a regulatory change (the “prudent person rule”) by the U.S. Department of Labor that spurred U.S. pension fund allocations to private funds.⁸ A recent estimate (June 2022) of the size of the private markets industry is approximately $11.7 trillion, which is reported to be more than 5x the size of the industry just 15 years prior ($2.2 trillion).⁹
Despite this robust growth, private assets remain a small fraction of public markets assets. For example, at the end of 2022, global public equity market capitalization was approximately $101 trillion — more than 13x global private equity.
Primary Participants in Private Markets Have Been Institutional Investors
Unlike public markets where, in 2023, according to Gallup, approximately 61% of individuals in the U.S. (or roughly 200 million people) own public equity directly or indirectly (through mutual funds),¹⁰ the investable universe of the largest segment of private markets (traditional drawdown funds) has been almost entirely held by institutional investors. Such investors include public and private pension plans, sovereign wealth funds, endowments, insurance companies, and prominent family offices. In 2021, the number of “accredited investors” eligible to invest in private assets in the U.S. was estimated to be a mere 13% of total households,¹¹ roughly 40 million individuals when considering everyone in a household as an accredited investor…
so, the amount of eligible investors to invest in private assets is only about 20% of the number of individuals who actually invest in public securities.
The Benefits of Investing in Private Assets
Institutions venturing into private assets have generally reaped the rewards of higher returns and greater diversification compared to those focusing solely on public securities.
Higher Returns — While there is a lot of debate in financial literature about whether private assets deliver higher returns to public securities, the data suggests that, over the long term, private equity, which is the most well-documented player, exceeds public equity returns by approximately 3–4% per annum.¹² ¹³ It’s worth noting that this comparison relies on average returns, and the results for all institutions can vary significantly, given the notable dispersion of private equity returns. Additionally, there is some evidence indicating that the premium for private equity returns may be narrowing as more capital flows into this arena.¹⁴
Greater Diversification — The significant boost in relative returns for private assets is bolstered by the belief that incorporating private real assets (like real estate, timber, agriculture, and infrastructure) into an investment portfolio can lower the volatility of returns without compromising overall gains. It’s akin to having a secret ingredient — lower correlation between the real assets and equities segments.
Illiquidity — In exchange for the expectation of higher returns and greater diversification, institutions are willing to accept the illiquidity of private assets. Many institutions are well-positioned to accept this trade-off, thanks to the long-term nature of their liabilities and the reduced likelihood of needing to sell assets for short-term cash needs.
Demand Driving Greater Access to Private Assets for Individuals
While there are some voices opposed to the expansion of access to private markets, in part due to some of the concerns stated above — illiquidity, perceived riskiness, etc. — it seems likely that greater access and participation will continue.
Let’s delve into the increasing demand that’s fueling the push for broader access to private assets:
Demand Is Growing — With the ongoing shift from defined benefit plans to defined contribution plans, private asset managers are seeking to expand into self-directed retirement plans such as 401(k) plans. At the same time, as investors accumulate greater wealth and face greater limitations on investment opportunities in public securities, there has been increased interest by investors, regulators, and industry to expand access to private markets.
Access Is Growing — There is a multi-pronged industry approach to expanding access of private markets to individuals. Some of the efforts include:
- Private wealth managers collaborating with private asset managers to develop pooled investment vehicles for the private wealth managers’ accredited investor clients, granting them access to funds that might have been out of reach due to minimum investment amounts and administrative burdens;
- Wealth managers and private asset managers teaming up with fintech firms like iCapital and RealBlocks to ease the administrative burden of having numerous individuals invest in funds; and
- Fintech firms like Moonfare devising methods for individuals to invest directly through their platforms, bypassing traditional wealth managers.
Institutional Investors Are Better-Positioned to Invest in Private Assets
Given the relatively short timeframe in which private markets have expanded, and the relatively small pool of individuals eligible to participate, it’s not surprising that large, sophisticated institutional investors currently dominate the market and possess significant advantages over individuals.
In contrast to the amount of information available about public market issuers and fund managers, individual investors face a number of constraints as they pursue private market investments.
SEC Takes Significant Action to Level Playing Field in Private Markets
In a move to provide greater standardization and disclosure, on August 23, 2023, the SEC adopted new rules to enhance the regulation of private fund advisers, which, over time, may bridge the gap between public and private markets reporting.¹⁵ The new rules require:
- Quarterly disclosure of fees, expenses, and performance in a consistent format.
- Broader disclosure of information regarding portfolio holdings or exposures of a private fund.
Since most sizable private fund managers already prepare quarterly reports and disclose fees, expenses, and performance, the new rule benefits all investors by requiring all managers to do so, ensuring consistency of reporting and greater detail on the information provided.
While this is indeed an important step forward, in my view, these changes may not have a substantial impact on benefiting individual investors as they seek to compare fund managers against one another.
As for information concerning portfolio holdings and exposures, the SEC is prohibiting the disclosure of such data to investors if the fund manager “reasonably expects that providing the information would have a material, negative effect on other investors,” unless the information is made broadly available at or around the same time.
Much like Reg FD, which is discussed above, this rule will likely substantially level the playing field for all investors, including individual investors.
Charting the Path Forward: Empowering Individual Investors in Private Markets
The democratization of private markets is a journey that will require time and a significant focus on educating individual investors.
Franklin D. Roosevelt once said, “Democracy cannot succeed unless those who express their choice are prepared to choose wisely. The real safeguard of democracy, therefore, is education.”¹⁶ When a friend shared this quote with me, I thought it perfectly encapsulated how crucial education is for the democratization of private markets to deliver its intended benefits to individual investors.
Among the challenges that advisors and investors face are learning the lexicon of private assets (IRR, MOIC, PME, etc.) and understanding how to assess the relative performance of funds — comparing like-for-like strategies, evaluating the use of leverage, conducting vintage year analysis, and comprehending the fees and liquidity provisions. Some of these analytical tools, such as comparing like-for-like strategies, are not new concepts for experienced public markets investors but require a different framework than what they currently use. Additionally, some tools, such as vintage year analysis, will be entirely new to even the most sophisticated public markets investors.
For the democratization of private markets to thrive, investors will need i) broader access to the thousands of different fund managers that raise capital in the private markets, not just curated sets of offerings, ii) reduced fees to participate, and iii) a secondaries market that allows individual investors to freely and cost-effectively trade based on their investment analysis and preferences.
In addition to these structural changes, the educational process, which imparts much of the knowledge and resources institutional investors have developed for evaluating private investment opportunities (an “institutional lens”), will take time. In the interim, individual investors should exercise caution as they allocate greater percentages of their personal wealth to private assets.
Footnotes:
1. Ranald C. Michie, The Global Securities Market: A History (The Oxford University Press, 2006), 8.
2. Katie Kolchin et al., 2023 Capital Markets Fact Book (SIFMA, 2023), https://www.sifma.org/wp-content/uploads/2022/07/2023-SIFMA-Capital-Markets-Factbook.pdf.
3. Richard Dale, The First Crash: Lessons from the South Sea Bubble (Princeton University Press, 2004), 7–21, https://www.degruyter.com/document/doi/10.1515/9781400851645/html.
4. Robert Eccles and Kazbi Soonawalla, “The Long and Winding Road to Financial Reporting Standards,” Harvard Law School Forum on Corporate Governance (July 20, 2022), https://corpgov.law.harvard.edu/2022/07/20/the-long-and-winding-road-to-financial-reporting-standards/.
5. IBID.
6. Investment Company Institute, “Characteristics of Mutual Fund Investors,” ICI Research Perspective 28, no. 10 (October 2022), https://ici-dev.ici.org/system/files/2022-10/per28-10.pdf.
7. “Worldwide regulated open-end fund size in worldwide equity and debt markets from 2011 to 2022,” Statistica, https://www.statista.com/statistics/1197811/share-investments-global-equity-debt-markets-type/.
8. Paul A. Gompers and Josh Lerner, What Drives Venture Capital Fundraising? (Brookings Papers: Microeconomics, 1998), https://www.brookings.edu/wp-content/uploads/1998/01/1998_bpeamicro_gompers.pdf.
9. McKinsey & Company, “McKinsey Global Private Markets Review 2023: Private markets turn down the volume,” https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/mckinseys-private-markets-annual-review.
10. Jeffrey M. Jones, “What Percentage of Americans Own Stock?” Gallup, May 24, 2023, https://news.gallup.com/poll/266807/percentage-americans-owns-stock.aspx.
11. Asset Management Advisory Committee, “Final Report and Recommendations for Private Investments,” U.S. Securities and Exchange Commission (September 27, 2021), https://www.sec.gov/files/final-recommendations-and-report-private-investments-subcommittee-092721.pdf.
12. J.P. Morgan Asset Management, “2023 Long-Term Capital Market Assumptions” (2023), 79. https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/portfolio-insights/ltcma/ltcma-full-report.pdf
13. Cambridge Associates, “Presentation to Asset Management Advisory Committee” (September 16, 2020), 1, https://www.sec.gov/files/cambridge-associates-private-investments.pdf.
14. Bain & Company, “Global Private Equity Report 2020” (2020), 24, https://www.bain.com/globalassets/noindex/2020/bain_report_private_equity_report_2020.pdf.
15. U.S. Securities and Exchange Commission, “Final rule: Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews” (August 23, 2023), https://www.sec.gov/files/rules/final/2023/ia-6383.pdf.
16. Franklin D. Roosevelt Quote, The Franklin D. Roosevelt Presidential Library and Museum, The Roosevelt Institute, https://rooseveltinstitute.org/fdr-library/.
About the Author:
Steve Blewitt is presently a Fellow participating in the University of Chicago’s Leadership & Society Initiative. Previously, Steve was the Chief Investment Officer and Head of Private Markets at Manulife Investment Management. In this role, Steve was responsible for leading global investment teams across a wide range of asset classes, including private equity and credit, real estate, infrastructure, timber, and agriculture. Manulife Investment Management’s private asset investment portfolios are managed on behalf of its affiliated insurance companies and their clients, including public and private pension plans, financial institutions, and family offices. Steve has served as a director of many public and private companies during his career, including two of Manulife’s U.S. SEC-registered investment advisors. Steve received his bachelor’s degree from the University of Chicago, and his M.B.A. from the Questrom School at Boston University.
