Advisors and securities lawyers are raising a collective eyebrow at a big push now underway by large firms and regulators to make private equity and other alternative investments more accessible to retail investors.
At a Securities and Exchange Commission conference last week, top industry watchdogs showed a general inclination to allow more ordinary investors to put their money into the sort of private funds that once were more or less the exclusive preserve of large institutions and the extremely wealthy. Natasha Vij Greiner, the director of the SEC’s investment management division, noted that many types of private equity, private credit and hedge fund opportunities remain open only to so-called accredited investors or qualified purchasers.
The SEC defines an accredited investor as someone with at least $1 million in assets (excluding a house) and an annual income of at least $200,000 for the past two years. A qualified purchaser is someone with at least $5 million in investments (excluding a house or business).
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Greiner, who is leaving her position next month, suggested opening up private market opportunities to investors beyond those in those two categories.
“Our understanding of private markets has increased significantly over the past several years, as have disclosure practices by both registered and private funds,” she said. “As a result, I believe it is appropriate to consider under what circumstances private fund investments should be available to investors who are not accredited investors or qualified purchasers ….”
Investor advocates: Limits exist for a reason
The SEC’s potential expansion of access to private markets is just one aspect of a general deregulatory push being made under President Donald Trump. Much like the lighter touch industry watchdogs are taking to cryptocurrency and other digital assets, it’s being met with skepticism from investors advocates.
Adam Gana, the president of the Public Investors Advocate Bar Association, said the majority of the cases he has taken on behalf of aggrieved brokerage clients over the past decade have involved “private placements” — securities sold directly to investors outside the public markets. He said the opaque nature of these products, and the barriers investors have to pulling money out, make them ripe for abuse.
“I have made a living getting investors their money back from fraudulent or unsuitable alternative investments, sold to them either by broke-dealers or RIAs,” Gana said. “Opening that world to more people is just going to lead to more catastrophic financial events for mainstream inventors. There’s no doubt in my mind that’s what’s going to happen.”
RIAs also not impressed
Advisors aren’t rushing to embrace private markets either. Erik Nero, the founder and president of Wilton, New York-based First Step Wealth Planning, noted that the high returns many times promised by private investments are often eaten up by high fees charged to investors.
Alternative assets should remain more or less exclusive to clients who can afford to pay the associated costs, Nero said.
“Retail investors will not miss out on anything, as they will not be able to experience the returns due to the fee structures,” he said. “Making private markets available to retail investors will only benefit the firms offering the products to them.”
Alex Caswell, a financial planner at Wealth Script Advisors in San Francisco, noted that the ratings firm Moody’s recently sounded the alarm about the risks private funds run by accepting more money from retail investors. As reported by The Wall Street Journal, Moody’s warns that private asset managers could be subjecting themselves to “reputation loss, heightened regulatory scrutiny and higher costs.”
Caswell said there are many reasons private markets can “create a dangerous environment for an investor.”
“Most importantly, the lack of liquidity is something that I think even advisors don’t pay close attention to when it comes to choosing private investments,” he said.
Big firms leading the charge to open alternative markets
Despite such warnings, most large wealth managers are locked in a race to distinguish themselves through their ability to provide investors access to private investments. Firms ranging from Edward Jones to Merrill are making a concerted push to make sure alternative markets further are open to a wide range of clients.
Speaking on Tuesday at an annual conference in New York, Morgan Stanley CEO Ted Pick said many of his firm’s clients’ portfolios are “underweight” in alternative assets like private equity and credit.
Now hovering around 5% of the firm’s assets under management, the allocation could easily be increased to 15% or even more, Pick suggested. Pick said the SEC is now reviewing a proposal for a “fund of funds” Morgan Stanley wants to start offering to accredited investors as a way to give them greater exposure to alternatives. Pick said Morgan Stanley is positioning itself as an expert in the “distribution of alts in a different way, in a diversified way, to clients.”
The focus on closed-end funds
At the SEC’s conference last week, Greiner and other regulators called particular attention to how a type of investment vehicle known as a closed-end fund can be used to provide exposure to private markets. Unlike open-ended funds, whose managers can issue and buy back their own shares as much as they want, closed-end funds issue shares only once. They also have greater latitude to borrow money with the goal of boosting returns for investors but come with higher risks as a result.
Last month, SEC Chair Paul Atkins announced the end of a policy that for more than two decades had placed some strict limits on closed-end funds’ ability to access private markets on behalf of retail investors. Since 2002, closed-end funds have been able to put no more than 15% of their total allocations into private investments, unless they were working with accredited investors who can put down at least $25,000.
“As a result, many retail investors have missed out on opportunities to invest in closed-end funds that invest in private investment funds, like hedge funds and private equity funds,” Atkins then said.
SEC Commissioner Hester Peirce, a Republican and advocate of deregulation, has similarly expressed support for eliminating barriers to private markets.
“Removing them would allow retail investors greater access to private investments through a closed-end fund wrapper with the benefit of professional management,” she said at the SEC conference last week.
“I would like to see more meaningful expansions as would many retail investors who resent being cut off from an increasingly large segment of the market,” she said at the same event. “The commission staff can take other steps at once to allow retail investors greater access to private markets.”
