Retail investors are slowly gaining access to private equity funds, observes Shanu Sherwani. Photo provided by the author

Retail investors are slowly gaining access to private equity funds, observes Shanu Sherwani. Photo provided by the author

In this guest column, Shanu Sherwani, a private equity analyst, looks at how and why private equity funds are opening up to individual investors.

Individual investors have long been excluded from private equity, having heard about the outsized profits given by funds but unable to access them. Private equity has historically generated much better returns than other private market methods. According to Pitchbook’s newest Global Fund Performance Report, growth equity funds have a 13.3% 15-year internal rate of return, outperforming private debt, funds-of-funds, real estate and infrastructure, among others. Meanwhile, buyout funds have the second-highest 15-year internal rate of return at 12.5%. During the same period, the S&P 500 returned around 9.7% each year, for example.

High barriers

Private market funds typically have a high minimum investment requirement that can be reached exclusively by institutions. This investment segment was once solely the domain of major professional investors such as institutional investors, superannuation funds and family offices. Still, a growing number of possibilities are now open to retail investors and their advisers. Given that private equity outperforms listed equities in most studies and often for a lower overall risk level, some PE funds have been investigating new ways to include private investors and advisers alongside institutions in the PE asset class. Furthermore, the hurdles to entry into private equity for direct investors have dramatically decreased. Historically, retail investors have been barred from participating in private equity investments, owing to the high investment minimums, the obligation to respond to irregular calls for funds, and the long-term nature of the asset class (7-10 years).

However, due to the competitive landscape of fundraising among institutions, it is unsurprising that private equity firms, which generally focus on large institutional investors, are broadening their target audience to include private investors.

With the advancement of financial technology, various businesses have emerged to pool investor funds or feeder platforms, lowering the minimum investment requirements for individual investors. Other modifications include:

- Providing investors with access to their capital through the payment of quarterly returns;

- Removing performance fees; and

- In some funds investing in full at the start rather than in periodic and irregular capital calls.

Feeder funds, which are increasing in popularity, are the preferred instrument for raising capital from private investors and are now used by a wide range of private equity fund managers. Feeder funds aggregate a pool of capital that invests alongside institutional investors in the master fund.

Not a mutual fund

Another way for regular investors to obtain indirect exposure is to invest in large alternative asset managers that have gone public. Although the high returns that private equity may provide are very appealing, retail investors should be aware of the repercussions of entering this market, including higher risk, illiquidity and funds being locked in many years. One of the primary issues confronting institutions seeking to attract retail investors is ensuring that they understand the nature of their investment and, maybe, providing secondary market remedies to the primary issue--illiquidity. Furthermore, through a multi-manager fund of funds approach, investors have exposure to many businesses; therefore, the risk is less concentrated.

Until recently, private equity was the domain of institutions and ultra-high net worth individuals. With increased access and more enticing profits, it’s clear why private equity is gaining traction. It is also growing in popularity as retail investors place a greater emphasis on private markets as a means of diversifying their financial portfolios. However, it is essential to note that private equity is a sophisticated asset type that can be effective when used appropriately as part of a diversified portfolio.

is a private equity analyst. He advises several top quartile private equity and real estate funds in Luxembourg.