Why the Democratization of Private Markets Isn’t What It Seems

Why the Democratization of Private Markets Isn’t What It Seems

The allure of private markets has grown exponentially since David Swensen popularized alternative investments through the Yale Endowment model in the 1980s.¹ Large institutions have steadily increased their allocations to private equity, venture capital, and real assets, seeking superior returns and diversification. However, individual investors have largely been excluded from these opportunities due to high minimum investments and regulatory constraints.

As institutional investors near their target allocations, fund managers are turning their attention to the vast, untapped pool of private wealth—the largest in the world. While this shift promises to democratize access to private markets, the reality is more complex and less favorable for retail investors than it appears.

Structural Challenges and Regulatory Constraints

The regulatory landscape governing private market investments is outdated, and the operational infrastructure of wealth management firms is ill-equipped to handle these complex assets. Approximately 80% of private fund offerings are available only to “Qualified Purchasers”—individuals or entities with at least $5 million in investable assets—limiting access for most investors.²

To accommodate retail investors while remaining compliant, fund managers must alter the traditional private fund structures. This often involves shifting from classic drawdown vehicles with capital calls to interval or evergreen funds. These structures provide periodic liquidity but often come with higher fees, including intermediary sales and placement fees, and may require liquidity buffers that can dilute overall performance.

The Rise of Interval and Evergreen Funds

Over the past decade, interval funds have grown significantly as a means to offer private market exposure to retail investors. Assets under management in interval funds increased from around $10 billion in 2010 to over $50 billion by 2022.³ While these funds provide greater access, they can introduce additional layers of complexity and cost:

● Higher Fee Structures: Management fees can range from 1.5% to 2%, with additional performance fees and intermediary charges.

● Diluted Performance: Maintaining liquidity buffers typically means a portion of the fund is allocated to cash or liquid securities, potentially reducing returns.

● Lack of True Private Market Exposure: Interval funds may invest in more liquid or lower-performing assets to meet liquidity requirements, deviating from traditional private market strategies.

Adverse Selection and Performance Concerns

The democratization of private markets through these vehicles may inadvertently expose investors to adverse selection. Top-tier general partners (GPs) often prefer to raise capital from institutions that can commit large amounts and have a long-term investment horizon. As a result, retail-focused funds may have access to lower-quality deal flow or less experienced managers.

Wealth management firms, optimizing for scale and profitability, may also contribute to suboptimal outcomes. They tend to promote products from well-known brands to minimize risk, potentially overlooking emerging managers who may offer better performance but lack established track records. The emphasis on scalability can lead to crowded trades and reduced returns.

Why Investors Should Exercise Caution

Retail investors need to approach private market opportunities offered through wealth platforms with a critical eye:

● Performance May Lag: Due to adverse selection and structural inefficiencies, these vehicles may underperform traditional private market funds accessible to institutions.

● Higher Fees Erode Returns: The layered fee structure can significantly impact net performance, diminishing the benefits of private market exposure.

● Complexity and Lack of Transparency: Understanding the intricacies of interval and evergreen funds requires a high level of sophistication, and disclosures may not fully illuminate the risks involved.

Conclusion

While the idea of democratizing private markets is appealing, the current mechanisms for providing access to individual investors are fraught with challenges. Structural changes to accommodate regulatory requirements often lead to higher fees and diluted performance. Additionally, the best investment opportunities may remain out of reach for retail investors due to GP preferences and wealth management practices.

Investors should conduct thorough due diligence, carefully assess fee structures, and consider whether the proposed benefits justify the potential drawbacks. In many cases, traditional public market investments or selectively chosen private opportunities may offer a better risk-return profile.

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_{1. Chronograph. (2024). The Evolution of the Yale Model for Institutional Investing,}

_{2. U.S. Securities and Exchange Commission. (2020). Accredited Investor Definition.}

_{3. Interval Fund Tracker. (2022). Interval Fund Assets Under Management.}

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