Trendspotter: Asset Managers Expanding Access to Private Markets

A growing number of asset managers are moving into private investment markets for alternative investments. They're offering those investments directly, sometimes in partnership with an outside firm, or acquiring firms that specialize in non-public assets.

In recent months, Vanguard extended access to its private equity offering from only institutional investors to two categories of self-directed ultra-high-net-worth investors — accredited and qualified; and T. Rowe Price announced a definitive agreement to buy 100% of Oak Hill Advisors, which specializes in private credit.

Macquarie Asset Management launched a private markets fund for accredited investors to access institutional-quality private equity, private credit, alternative yield, and private real assets; and Franklin Resources Inc. agreed to buy Lexington Partners, one of the largest independent managers of secondary private equity and co-investment funds, for $1.75 billion. (Macquarie is partnering with Wilshire Advisors on its offering; Vanguard partners with HarbourVest Partners.)

In late September, the Securities and Exchange Commission's Asset Management Advisory Committee unanimously approved a recommendation to expand retail investor access to private investments, and early this month SEC Chairman Gary Gensler, in a statement to that committee, asked staff to consider how to bring greater transparency to the private fund markets, which is currently worth about $22 trillion.

These alternative investments are still largely limited to accredited investors (those with a minimum net worth of $1 million or more than $200,000 in annual income and financial professionals with specific licenses) and qualified investors ($5 million or more in investments, excluding primary residence or business property, or at least $25 million in private capital), but the potential beneficiaries are growing.

But the private investment market is starting to penetrate the wealth channel, moving from ultra to high net worth, and there are expectations it will eventually be available to the mass affluent, said Rob Sharps, president and head of investments at T. Rowe Price.

The private market includes private equity, which has its greatest share, private credit markets, real estate, infrastructure and real assets.

The Drivers

Strong overall performance vs. public markets. McKinsey reported that private equity outperformed public market equivalents in 2020, with net global returns of over 14%. That's not as great as the S&P 500, which gained 18% that year, but well above the roughly 6% return of the EAFE index, which tracks the stocks in most developed markets, excluding the U.S. For fiscal 2021, ended June 30, private investments contributed to the 40%-plus returns for the endowments at Yale and Princeton.
The potential for stronger gains than those in the public markets. Private equity has historically delivered a 300- to 400-basis-point illiquidity premium relative to traditional equity indexes, said Tony Davidow, president and founder of T. Davidow Consulting. BlackRock forecasts that over the next five years, publicly traded stocks will gain about 6% a year vs. over 19% in private equity and bonds in the public market. It recommends investors change their allocations from traditional 60/40 stock/bond split to 50/30/20 with the last 20% representing alternative investments, including private equity and private debt.
Extremely low returns in the fixed income market. In the current low rate environment where the 10-year U.S. Treasury yields around 1.5% and spreads between corporate bonds and safer Treasuries are tight, there is little income and limited price appreciation opportunity for investors. But if rates rise in 2022, even slightly, private credit instruments, which usually have adjustable rates, will pay a slight premium.
The declining size of public markets, especially for stocks. McKinsey reported that the number of public companies listed in the U.S. dropped 20% between 2000 and 2020, from 5,000 to 4,000. The Wilshire 5,000, formed in 1974, now has about 3,500 stocks. Companies are staying private for longer.
A growing number of opportunities in the private market. Through the third quarter of this year, private-equity firms disclosed $868 billion in deals and deals are on track to reach a record $1 trillion, according to Ernst & Young. "Private funds are growing," SEC Chairman Gensler said Wednesday, adding that they are worth about $22 trillion. He is pushing the SEC to bring greater transparency to this market.
Asset managers, under fee pressure, looking for ways to become more competitive. Offering private investment products can help asset managers attract more actively managed assets that pay higher fees and help diversify portfolios.

The Buzz

Fran Kinniry, principal, global head of private investments, Vanguard

With private equity growing in size within the capital markets structure and its liquidity premium, it can serve investors well if they have a long duration of 20 years or more. The big risk is the inability to get out of it.

You really want to advise clients investing in private equity that they are committed to that asset class for 10, 20, 30 years. If you have that kind of duration, we think it makes sense to think about private equity inclusion. But if you're not going to have access to the best private equity managers and have the ability to select private managers, it probably won't give you a return that's worth the illiquidity.

Also, if you are running a $1 billion RIA and want to do 20% of assets in private equity, you will not be attractive to the Andreesen Horowitzes of the world. This is an area where manager access and manager selection is the key to success.

Rob Sharps, president and head of investments at T. Rowe Price

It used to be that companies could get a lower cost of capital if you went to public markets in most instances. But more frequently, they can get equally attractive terms going to private markets.

We incorporated private equity and private credit into our mutual funds over a decade ago, but we're limited in [how much] we can invest in our '40 Act vehicles. … Under the Liquidity Rule, we can't have more than 15% in illiquid securities.

As mega cap companies Facebook, Google and DoorDash raised meaningful rounds of private capital before they became public. We want to be able to take advantage of those types of investment opportunities.

Most clients we talk to intend to allocate more client assets in private alternatives. One of the attractions for us is that this is an area where investment insight and fundamental research can drive durative returns.

Tony Davidow, president and founder of T. Davidow Consulting and former alternative beta and asset allocation strategist at Charles Schwab, from his Innovations in Private Markets blog and new webcast series with Bob Powell from TheStreet.com

There are fewer and free public companies but there's a growing number of private companies. … They give you a much richer palette to select from.

What we find interesting about private equity is the opportunity for growth over the long run; private credit of course provides the initial appeal of additional income in a low return environment.

Private markets broadly help solve for an advisors playbook, help them provide different tools to help clients achieve their goals over the long run.

There has been a growing demand for private equity based on their attractive absolute and relative returns.

Before investing in private equity advisors and investors must understand the various stages of development and the corresponding associated risk, from venture capital through growth to buyout opportunities. As private equity has become more available to a larger group of investors, advisors need to get up to speed about product innovation and the options available to their clients.

Greggory Warren, senior stock analyst, Morningstar

Consolidation is the overarching trend for asset managers going forward … consolidating their own funds or buying similar-type companies that can scale up. They're feeling a lot of pressure on fees and the best way to offset that is to bulk up the size of their product set. Absent great performance, they can go outside their core area to pick up products that are growing and, more important, that are not exposed to the growth of low-cost index-based products.

Everyone realizes the need for more scale and the need for more diversity in portfolios in order to be truly competitive in the long run. … I'm hearing that the prior 10%-15% institutional mandate for alts is now 15%-25% and for high net worth too.