As sinking stocks and recession fears spur interest in alternatives, fund managers and retail marketplaces are chomping at the bit for ‘mass affluent’ investors.
After years of private equity firms aggressively marketing themselves to high-net-worth investors and their financial advisors, the message seems to be breaking through.
Facing a bear market and bleak economic outlook, marked by inflation, supply chain imbalances and a hawkish Federal Reserve, more RIAs and high-net-worth investors are warming up to alternative investment funds – such as private equity, hedge funds, venture capital and private debt strategies – in their search for yield, according to advisors and investment managers who spoke with Forbes.
“I think [retail] appetite is increasing,” says Donald Calcagni, Chief Investment Officer at Mercer Advisors, which oversees roughly $42 billion of client assets. “There is a sense among investors, broadly, that there are gains and opportunities in private equity and private credit that until recently, have not been available.” The growth in demand is especially “coming down market,” says Calcagni, referring to high net worth investors with assets between $1 million and $25 million.
“The trend is 100% towards increasing [retail] allocation” into alternatives funds, says Ken Brodkowitz, Chief Investment Officer at Gries Financial Partners, a Cleveland-based advisory group that oversees about $1.15 billion in assets for high-net-worth clients. “If you can get 10% plus [returns] in alternative investments, where you can control the outcome to a much greater degree, clients are extremely interested in that.”
Alternative investment firms traditionally have relied on institutions, like endowments and public pension systems, as well as the ultra rich to fund their investments. However, per the U.S. Securities and Exchange Commission’s “accredited investor” threshold, anyone with more than $1 million in investable assets, $200,000 in annual income or who meets certain investment industry qualifications (a provision added in 2020) can legally invest in private market funds. That leaves a big untapped market for fund managers.
According to a survey conducted last month at the 2022 Morningstar Conference, 84% of about 300 investment professionals and financial advisors said they now recommend qualified clients put some money into alternatives funds. The survey, conducted by private funds platform CAIS, also found that a third of advisors believe a traditional portfolio of stocks and bonds “is no longer effective”; over two-fifths said the same about the traditional 60/40 allocation between stocks and bonds.
Those concerns reflect widespread investor anxiety, following a historically great run for stocks: Between 2010 and the end of 2021, the S&P 500 returned investors an annualized rate of return of about 14.5% (including the reinvestment of dividends). This year, the S&P 500 is down over 20%.
“I think what we’ll start to see now that we’re seeing a downturn in the market is people looking at the historical private market returns relative to the public markets,” says Stephen Brennan, head of private wealth solutions at Hamilton Lane, who says that private equity and private credit have outperformed the public markets “in at least 19 of the last 20 years.”
Private equity’s historical performance is a hotly contested topic. Industry critics say that fund managers overstate their investment performance by relying on a metric called the Internal Rate of Return (or, “IRR”), which often does not reflect a fund’s true rate of return for investors.
“Even as the stock market is in free fall and interest rates are rising, private equity (PE) funds continue to pursue new investors, peddling the myth that private equity returns defy the laws of financial gravity and yield strong returns even in periods of economic turbulence and declining values of publicly-traded companies,” wrote Eileen Appelbaum and Jeffrey Hooke, two academics, in a paper out last week.
Some brokers at Merril Lynch were left feeling burned by putting money into Blackstone, an early PE entrant among advisors and the high-net-worth crowd. Today, Blackstone, the world’s largest private equity firm, has sourced about a quarter of its $915 billion in assets under management from retail investors. Apollo Global Management, another leading private equity firm, acquired a retail focused asset management business earlier this year to beef up its own retail offering.
Tech platforms, in addition to buyout shops, are eyeing the retail-fueled, advisor-enabled gold rush. CAIS and iCapital, two private fund marketplaces that connect RIAs with private fund managers, have become unicorns. CAIS, which was founded in 2009, raised $225 million in January at a valuation of over $1 billion. iCapital, founded in 2013, raised $50 million that same month—at a reported $6 billion valuation. Large private equity investors, including Blackstone, KKR and Apollo, have invested in one or both of the companies.
Other private fund marketplaces are looking to bypass advisors altogether. Moonfare, a Berlin-based company founded in 2016, and which gives accredited investors access to private fund placements, has facilitated roughly $1.5 billion in investments, according to its website. Moonfare clients can register and start investing “in as little as 15 minutes,” with an investment minimum of $60,000.
Prometheus, another retail platform that recently exited stealth (and whose backers include Thiel Capital, the investment arm of billionaire venture capitalist Peter Thiel) has an even lower investment minimum of $25,000. Low minimums are core to the “democratization” of alternatives industry, says Michael Wang, a former hedge fund star who founded Prometheus last year. “The minimum at a lot of hedge funds is anywhere from $1 million to upwards of $20 million, so even if you’re a wealthy guy with $5 million, [putting] $1 million into a single fund is difficult.”
While private fund managers and tech startups celebrate the rotation of private wealth into private equity, industry critics are left shaking their heads. They believe that many high-net-worth investors who put money into alternatives are going to be left disappointed.
“There’s the fee to invest in the fund, there’s the fee to pay the middleman, there’s the fee to pay the brokers or the registered investor advisor… in a situation like that, fees eat up returns,” Eileen Appelbaum, the co-director of the Center for Economic and Policy Research in Washington D.C, tells Forbes. “I think it’s going to be a rude awakening.”