Retailization in private markets: Solutions to operational challenges
The private markets landscape is evolving rapidly, with a growing trend towards entities which accept retail investors, but there are operational must-haves to make it a success.
Making alternative investments more accessible to high-net-worth investors has gained traction in the last few years as managers search for new sources of capital. While traditionally the preserve of institutional investors, private assets increasingly appeal to high-net-worth investors because they offer diversification and alternative risk/reward profiles to mainstream markets.
This shift presents both opportunities and challenges for fund managers, administrators, and other stakeholders in the industry. As managers consider whether - and how - to embrace this trend, it is crucial to understand the implications across various aspects of fund management and operations. Below, Citco explores some of the key considerations.
The right investment structure
There are a variety of options able to facilitate retail investor access to private markets, with innovative structures emerging to tackle liquidity issues.
One such structure is business development companies (BDCs). BDCs are hybrid closed-end funds that invest most of their assets in private US operating companies – typically via debt investments – and share similarities with both operating companies and registered investment companies. BDCs can be structured so that they are publicly traded, non-listed or privately offered, and some use evergreen structures that run as a parallel or alternative entry point into a closed-ended strategy. Meanwhile in Europe, European Long-Term Investment Funds (ELTIFs) are paving the way for investors to access private markets more efficiently.
Whichever structure is selected, the influx of retail investors into private markets necessitates significant operational adjustments. Funds must revisit their operating models and staffing to ensure they have the procedures and expertise to manage such strategies effectively. This may involve additional training for existing staff or outsourcing to providers who have the right systems in place.
Distribution of products is also a key consideration. In the US, for example, it is vital to have a registered investment adviser (RIA) and broker strategy to get funds listed on larger platforms, as this improves the likelihood of capital raise success. Building and maintaining relationships with key distribution partners is a key to success, and without this strategy, it may be difficult for managers to access retail investors.
As most retail investors are likely to come through an investment platform, in many cases managers will only have to correspond with investment platforms rather than each underlying investor.
However, they may still need extra operational capacity to be able to provide additional guidance on NAV statements, valuations, and other aspects of fund performance and operations to make complex investment concepts more accessible and understandable to a retail audience.
As part of this, investor education is an important consideration. Ensuring end investors understand the illiquid nature of the products - meaning they may not be able to get their money when they want it - is paramount.
Technology: The Backbone of Retail Access
A primary consideration for all managers looking at retail alternatives is technology. Managers need the technological infrastructure in place to support a broader investor base before embarking on any retail alternatives initiative, and they must identify suitable distribution channels and collaborate with transfer agents to establish seamless connectivity between distributors and share register systems. This integration is vital for efficient investor onboarding and management.
Furthermore, managers must be comfortable that their fund administrators have the robust operating systems capable of handling both liquid and illiquid assets in higher volumes, something that can be a reality from time to time. These systems must also manage complex investor allocations and automate investor reporting to cater to the increased demand for transparency from retail investors.
The technological challenges lie not just in implementing these systems but in ensuring they can scale and adapt to changing regulatory requirements and investor expectations. Managers must rely on their administrators and transfer agents to maintain operational relationships with distribution partners, so that they can make data available for the distributor to improve the underlying investor and adviser experience.
Operational Cost Considerations
With so many factors at play, the cost of market entrance is significantly higher when targeting retail investors, so understanding that runway and sunk cost is important if funds are going to be sustainable on a cost basis.
The transition towards retailization inevitably impacts profitability for all stakeholders involved. The necessary technological upgrades, operational adjustments, and enhanced regulatory compliance measures translate to increased costs. These financial pressures may prompt stakeholders to reevaluate their existing operating models and IT infrastructure to identify efficiencies and cost-saving opportunities.
The Path Forward: Tailored Solutions and Collaboration
The decision to embrace retailization in private markets is not one to be taken lightly. It offers the potential for significant growth and diversification of investor bases, but also comes with substantial operational, technological, and regulatory challenges. Fund managers must carefully weigh these factors against their long-term strategic goals and operational capabilities.
For those who choose to pursue this path, success will hinge on thorough preparation, strategic partnerships, and a commitment to ongoing adaptation. Working with asset servicers with extensive global experience and a deep understanding of complex fund structures will allow managers to address the technological, operational, regulatory, and financial implications head-on, and position themselves to capitalize on the opportunities presented by the retailization of private markets, while mitigating associated risks.
Citco has expanded its Private Markets offering to include services for European ELTIFs and US SEC registered entities accepting retail investors, initially servicing unlisted Business Development Companies (BDCs) used to invest in private markets.