The perils of democratising private markets

The writer is managing partner designate at the Pictet Group

At a time of lofty stock market valuations and low interest rates, investors are seeking — and increasingly finding — ways to gain greater exposure to so-called “alternative” investments, private equity in particular.

This democratisation of private markets has merits. After all, why should professional investors have monopoly rights to what has been a strongly performing and diversifying asset class?

The question is not “if” this process should happen, but “how”: to what extent and with what safeguards in place? And whether regulators have adequately considered the risks involved, especially given the unique characteristics of the current investment cycle which has been marked by extraordinary central bank support for markets?

There are a number of initiatives under way, led both by investors and regulators, with the objective of making private markets more accessible.

Some retail investors are seeking exposure simply by buying shares in publicly traded private equity firms. Others are using private equity investment trusts to participate in the market. Then there are technology platforms, some of which allow individuals to invest as little as €50,000 directly into private equity feeder funds.

The motivations of retail investors are understandable. Traditional equity opportunities are being squeezed. Public companies have been delisting, while high-growth companies are staying private for longer.

This is reflected in terms of the growth of the industry and the returns it has generated. Despite an initial “Covid correction” last year, the private equity industry broke a 40-year record in the first six months of 2021, striking 6,298 deals worth $500bn, according to figures from Refinitiv.

Regulators have also been working behind the scenes. Their reasons are different and follow the recent trend of deregulation. This has allowed retail investors direct access to the world of finance, from trading securities on the Robinhood app to cryptocurrencies on fintech Revolut.

In Europe, policymakers created European Long-Term Investment Funds — and are currently reviewing this regime — with the objective of allowing savers in defined contribution pension funds and non-professional investors more direct access to deals that require long-term capital. Meanwhile, regulators in the UK are working on a similar regime to allow pension fund savers and non-professional investors access to alternative asset classes.

Across the Atlantic, regulatory changes have made it possible for so-called mom-and-pop investors to gain access to private equity via their defined contribution pension plans, the 401(k).

The result is a fresh and growing flow of capital into private markets. Much of this is coming from investors who, until very recently, had found private equity largely out of reach. On a theoretical level, none of this sounds especially problematic. However, it is not…