The use of private market funds by sophisticated private investors is on the verge of becoming mainstream.

Wealth Managers that are able to deliver a suitable and compelling solution will deliver rewards for their clients and themselves. 

Key Takeaways

• There is a strong investment case for private markets
• Suitability rules are a barrier, regulators are opening up this asset class in some countries
• Access to private markets has been challenging for wealth managers and access to QUALITY managers almost impossible
• Investment minimums are a barrier, and make it difficult to hold a diversified portfolio for individual private clients
• Regulation is not keeping up, but it is both easing (from an investor access point of view) and likely to tighten in holding private companies and managers to account.

Context:

Titanbay provides a platform that enables investors to access Private Markets funds – a market that has traditionally been closed off to the majority of investors due to high barriers to entry; extremely tight regulatory controls and significant administrative overheads. 

This is a timely offering: 

• Demand outstrips quality supply, and demand is growing, judging by increasing popularity with institutional clients
• Getting access to private markets has been a challenge even for UHNW clients in the past
• HNW investors will play a much more important role in this space going forward, allocating an additional 5% of their portfolios by 2025 which represents ~£1 trillion AUM

Mercer has been collaborating with Titanbay in removing the barriers to access private markets funds through a technology platform and a feeder fund investment structure. The platform is able to leverage Mercer’s superior access to world-class GP’s and best ideas on private markets. They are able to offer something that has been typically out of reach of many wealth managers and their clients.

The Investment Case:

Private Markets cover:

• Private equity 
• Real estate 
• Private debt
• Infrastructure
• Natural resources

The reasons to invest in private markets is compelling:

• Superior risk adjusted returns by unveiling of alpha opportunities
• Greater diversification away from listed markets and access to broader opportunity set
• Illiquidity premium available to the providers of long term capital
• Finding ideas generates alpha (and USPs) against public markets (this is also important within private markets)

However, some managers are not giving the returns expected, considering the downsides of risk and illiquidity (very large managers, in particular). Participants gave examples of Morgan Stanley and JPM’s performance assessments, which were similar to those of public markets – hardly gaining any illiquidity premium at all.

Investment trusts can be a way to access these markets, however, the successful ones trade at a premium and they do not give an opportunity to raise capital being closed-ended.

It’s also the case that managers that do demonstrate good performance tend to do so repeatedly and are then very much in demand.  The best managers will constrain capacity and will reserve allocations to ongoing clients who subscribe to multiple vintages.

Research across all private market classes has shown those who do well are consistent, but hard to access.

Barriers:

A multi-choice poll showed the participants considered the greatest barriers are perceived as:

1. Investor suitability regulatory requirements 
2. Access
3. Investment minimums

Investor Suitability is considered a show-stopper, not only because of the regulations, but it’s also the desire of wealth managers to bring opportunities to private investors safely.

Suitability Challenges:

The investment into private markets can be like a 'lobster pot' – easy to get into, but not out of!  Added to this the regulatory hurdles for private investors mean it can be considered only for investors with higher levels of wealth.

Whilst the regulators are increasingly open to conversation on these assets, they are very cautious (in 2020, SEC opened up to allow 10% of US 401k holding to this).

The emergence of tech-driven platforms goes some way to help with this process:  Titanbay has mapped out logic on the platform to provide full suitability tests specific to each location.  Having discussed this with many of the regulators, to check the logic, it means that if an investor passes the criteria on the platform, the wealth manager can be assured of operating within the appropriate suitability boundaries.

There’s still a need to reduce the risk of mis-selling, and hence a fully auditable track record of decisions is needed – and must be supported on platform. Titanbay and Mercer have worked with GPs to get transparency and to monitor how information is consumed.

There were still concerns about appropriateness for private clients - as assets are illiquid - hence an investor may need to 'get out' after an unforeseen life event.  By investing through a feeder fund and platform there are some ways of mitigating these risks:

• 10% of capital calls is held up front to avoid default (draconian rules of not making a call payment means losing the whole investment)
• An investment can be offered to the rest of the community (who are already like-minded investors classed as suitable) – creating a secondary 'market'
• A further backstop can be offered where an institutional buyer can step up.

Also noted, was that returns on Private Markets are not necessarily at the end of the investment – returns can start even before all calls are in through distributions. May even get back 70% of the original commitment in this way in a period of 4-12 years.

Getting Access and Investment Minimums:

Access to quality managers in private markets for private clients is challenging, due to capacity constraints, and secondly due to minimum investment requirements.   

Whilst the median for performance in Private Markets rolls around 20%, there is a high dispersion rate amongst the performance of managers across all types of funds, so manager selection really matters. Private Markets managers have a different skill set to public markets:

• Add value through hands-on management
• Networks and relationships is key top sourcing opportunities
• Contracting and structuring skills are key to successful outcomesHowever, good managers are selective about who can invest, and it is almost impossible for wealth managers to get access for private investors.

The collaboration between Mercer and Titanbay sets out to solve these issues via a platform designed for Wealth Managers – a B2B utility than can be white-labelled – customers of the wealth manager can access the platform for onboarding and reporting.  

Mercer provides detailed research on quality managers.  Using it’s relationships and knowledge this is made available on platform to help select the right portfolio of assets.  Leveraging Mercer’s relationships also means access to managers that are otherwise closed to new investors.

In addition, by providing access to the platform, wealth managers are able to invest for a small number of clients alongside a larger cohort due to the feeder fund structure. 

Building a private Markets exposure should be similar to building a public portfolio – matching client objectives with a variety of asset classes, such as: private debt, VC growth and buyouts for income focus; and PE and opportunistic real estate for capital gain.

Access through a platform, into a feeder fund structure can provide solutions that are tuned to desired exposure (sleeves are by asset type and region, for example, which can be mixed and matched).  By grouping private clients through this mechanism it means that minimum investment requirements are much smaller and, at the same time, the manager receives scale and access to a diverse client base without the concern of administrative overhead or risk from smaller investors.

There is also an increasing focus on other themes and specialties – social impact; sustainable opportunities; climate; governance; and litigation finance - these are becoming a part of the suitability process for private clients.  These further generate a need for the ability to diversify in a private markets’ portfolio.

Note: there were questions specifically on 'co-investment', and it was made clear that via a platform the focused is on access to funds and not direct opportunities.  However, the manager offering co-investment, in theory, could be part of the selected managers if it satisfied the right criteria.

In final words - are Private Markets a sustainable option for private clients?

There are views that Private Markets is where all the 'dirty money' goes to.  It is true that private companies and private markets managers are not held to account.

Today, there is a high variability of regulation, particularly around source of money – Luxembourg has new regulations and constantly evolving; Cyprus has barely any controls.

The view is that regulation has to come… and markets with more mature regulation will become more attractive for private investors to invest confidently.

There is no doubt that this is a growth area that will keep on growing.  Getting access to these opportunities will become a must for wealth managers.