Alternative Investments for Retail Investors – Current Status

Alternative investments such as private equity, private debt, and real estate are long term in nature with higher fund management charges and a complex structure. So, they are more suitable for institutional investors for the additional growth potential than peers in public. Hence retail investors also want to include alternatives in their overall portfolio of investments for higher growth and diversification.

Customer Segments

For HNI/UHNIs across the globe, regulators and wealth managers stipulate a minimum investment amount and other criteria to select eligible investors based on their investment capability, risk profile, knowledge about the investment on long term nature, frequency of valuation, liquidity issues, fund management charges and profit-sharing arrangements beyond baseline returns. Firms typically use a questionnaire to assess investors’ knowledge and to avoid legal complications later.

For ordinary investors in USA, the idea of 401(k) workplace retirement savings plans investing in alternatives through their target-date funds has been in talks for many years but still under discussion.

Apart from start-ups, many companies choose to remain private to avoid regulatory obligations after listing. Employees of PE/VC funded firms holding unlisted equity are also investors of private equity.

Investment avenues

UHNI/HNIs invest in alternative assets through their financial advisors/wealth managers, who partner with deal networks and marketplaces such as iCapital, for alternative funds and secondary investments. Most of these marketplaces offer portfolio management and analytics capability for investments made through their platform. Though they cater to retail investors, institutional investors have a higher hand in deciding valuations.

For retail investors, many USA based alternative fund managers are creating evergreen funds without a fixed end date. These funds address issues around liquidity, minimum investments, and reporting requirements.

Industry-led technology working groups in various markets are considering mutual fund tokenization to benefit from diversification opportunities, faster settlement, lower operating costs, efficiency improvements, transparency, and fractionalization. Few leading alternative asset managers are already offering tokenized funds, which is expected to be a game changer.

Regulatory updates

As per SEC norms, accredited investors (earning $200,000 per year or with net worth of $1 million) are qualified to invest in alternative assets. SEC introduced new rules for Private Fund Advisers to protect private fund investors by increasing transparency, competition, and efficiency in the private funds market. As per these norms, advisers should provide quarterly statements containing fund fees, expenses, and performance, and annual financial statement audit of each private fund it advises and, in connection with an adviser-led secondary transaction, a fairness opinion or valuation opinion.

Upcoming European regulation ELTIF 2.0 (European Long-Term Investment Funds) is aimed at attracting retail investors by removing cap on minimum investment, wider the range of investments ELTIFs can make and rules that allow the creation of more diversified structures via funds of funds. It also simplifies investment rules, increases concentration limit, permits indirect strategies, and modified borrowing limits.

UK regulation for LTAF (Long-Term Asset Fund) allows investors to access private equity, private credit, venture capital, infrastructure, real estate, and collective investment vehicles that invest in private asset classes. It permits restricted mass market investment for retail investors alongside high net worth and sophisticated investors. Retail investors can also invest in LTAF through their self-select DC pension schemes and Self-Invested Personal Pensions (SIPPs).

Conclusion

While new regulations are aimed at permitting retail investors to participate in alternative assets, they have also introduced appropriate investor protection norms in specific markets. Global assets under management in alternatives is now about $11 trillion out of which $1 trillion is held by retail investors. At 7% growth per annum, this number is expected to reach $1.5 trillion by 2025. Also, fund tokenization will be a game changer for retail investors who wish to invest in alternative assets, as it’s well suited for cross border distribution.