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Private Equity for Potential Retail Investors


Retail participation of the capital markets have never been higher in history, enabled perhaps, by a combination of policy, awareness, and financial technology. The logical next step for the next stage of retail inclusion could be private equity investment.
Over the past two decades, according to the U.S. Securities and Exchange Commission (SEC) the S&P 500 has returned an average of 8% with a standard deviation of 17%.While on the other hand, Private Equities in the same period, returned an average of 12% with a standard deviation of only 14.5%. In other words, private equities, over the long term, yields a higher return on average with lower volatility.
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While the author needs point out that it is very difficult to accurately reflect the investment returns for a private equity fund as a single percentage number—as opposed to its public counterpart, and that the return is likely inflated and skewed in favor of the fund managers—the deviation is often not material and the result of lack of a better calculation, rather than malice.
Alternative measurement rather puts the long-term average return of private equity fund to be approximately same with public-listed companies. While these measurements do not conclude that private equity funds outperform its public counterparts—seemingly bust the myth as of private equity yielding superior return—it also quietly acknowledges on the other hand, that even net of taxes and high fees, private equity does not underperform.
Currently, retail investors have very limited access to private companies. Yet, overwhelming majority of the companies today are private, not public. Private companies power a significant portion of the world’s economy.
Traditional investment principle calls for diversification of investments. Today, a typical “retail fund” has achieved diversification rudimentarily and simply by investing several public companies, in its shares or bond.
However, regardless of whether the investments are equity or debt, and the number of companies diversified, the natures of these investment, that is, they are all public companies, would mean the returns are highly correlated. Investments in alternative asset classes is key to give retail investors uncorrelated returns while achieving better diversification.
Looking at alternative investments potentially suitable for retail investors, private equity funds would clearly win out over hedge funds, venture capital funds or cryptocurrency funds—each carry extreme volatility and risks.
Additionally, one principal driver of the state-sponsored retirement program for retail investors, is one that to encourage the everyday investors to invest over a very long period for a high return for their retirement. Private equity investments force a long-term investment given its lack of liquidity and long lock-up period, often around ten years.
The last potential benefit is the greater participation of companies in the growth stages before listing. Greater investment in challenger and innovator space often means greater inclusion and competition, which ultimately, benefit consumers and societies. Indeed, the world’s largest securities regulator, the Securities and Exchange Commission of the United States, via its Chairman Jay Clayton, commented:
“When retail investors participate in our markets, how broad a spectrum of investments do they have? I think that spectrum has been getting relatively smaller. Because we have fewer public companies, companies are waiting much longer in their life cycle to go public, which means that retail investors have less access to the market as a whole. And I fear, less access to companies that are well-established, but still growing.”
That said, private equity investment space will likely face hurdles and challenges. Significant regulatory oversight would need to be exercised over private equity fund managers—especially over its fees. Given the high fee nature of the fund, and that a performance fee is often charged, it can be argued that should the fees are able to be reduced, private equity funds on average, over a long investment horizon, would be able to outperform its public fund counter parts.
The lack of publicly available information on private equity fund strategy, or on portfolio holdings once funds start investing, and its lack of liquidity—capital is typically locked up until portfolio companies are sold—may, indeed, make direct investment in private equity funds “not ready for primetime” when it comes to retail investors.
To address these challenges, the opening of private equity investments to retail investors should be gradual and controlled. It should not form over, say, 20% of a personal’s total investment portfolio. If investing through a retail fund, the fund manager should absolutely be prudent in terms of private equity investment’s weight in the retail fund. On the other hand, if investing personally and directly, the retail investor, or his or her financial advisor, need to be sure that the investor understands the risks and locked in nature of the investment and that the invested amount cannot exceed a small percentage of a person’s total liquid investable asset or it would be reckless.
As the market continues to open to retail investors whether through state-sponsored programs, policies, or financial technology, it is not inherently a blasphemy to think and consider the merit of allowing greater, but controlled, gradual opportunities for retail investors access to private equity type investment. Indeed, some of the pilot tests have already happened in the United States where the SEC Information Letter from the U.S. Department of Labor, issued in June 2020, has opened a feasible way for most Americans to make their first significant investments in private equity via liquid, multi-asset vehicles that invest in a range of different securities, including stocks, bonds, and the shares of private equity funds.
However, the jury is still out to whether this ultimately is a good idea.