As the financial landscape evolves, regulators are considering expanding private markets to include a broader range of investors. The crucial question is whether the current market structure can adequately support retail investors’ participation. Issues such as illiquidity, inconsistent performance reporting, and the misalignment of incentives between fund managers and investors present significant obstacles, particularly for less experienced individuals.
A recent legislative initiative aims to provide retail investors with universal access to private capital.
For example, in August, the Trump Administration enacted an executive order titled “Democratizing Access to Alternative Assets for 401(k) Investors,” marking a shift toward inclusivity in investment opportunities. Meanwhile, European regulators have also made strides, with the UK government lowering the minimum investment threshold in long-term asset funds to £10,000. The European Union has gone further, introducing a Long-Term Investment Fund product that has no minimum investment requirement.
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The challenges of accessing private markets
While retail investors can now engage with semi-liquid or illiquid private markets, doing so without a comprehensive understanding of potential risks could lead to substantial financial losses. One major hurdle is the difficulty in evaluating the actual performance of private investments. The returns reported by these funds are often opaque and lack precise benchmarks, complicating the assessment of their viability.
Illiquidity and limited transparency
Private capital funds typically operate with lengthy investment horizons, averaging around ten years. However, many funds do not return capital to investors as expected. A recent analysis by Palico of 200 private equity (PE) funds revealed that over 85% failed to return investors’ capital within the anticipated timeframe, with many successful investments taking more than a decade to yield profitable exits. Secondary markets provide limited alternatives for investors seeking liquidity; while it is technically possible to sell stakes, actual transactions are infrequent and often occur at a discount to the fund’s net asset value. The scale of these secondary markets is also significantly smaller than public markets, representing less than 5% of the primary market in PE and under 1% in private credit.
Understanding performance metrics
The lack of transparency in private markets raises critical questions regarding the performance of these investments. Historically, private equity funds from the 1990s and early 2000s consistently outperformed public markets. However, with the recent influx of capital into the sector, the ability to maintain such outperformance has diminished. This oversaturation has inflated asset valuations and made it increasingly challenging for fund managers to identify sustainable strategies that consistently yield returns above their competition.
Changing performance expectations
As the market matures, expectations for returns have shifted downward, with typical internal rate of return (IRR) targets decreasing from around 25% in 2000 to approximately 15% today. To adapt to this changing environment, some firms have adjusted their fee structures by lowering or eliminating the traditional 8% hurdle rate, while increasing their share of capital gains beyond the historical 20%. This adjustment ensures that fund managers maintain their compensation even as overall returns face compression.
The impact of agency problems
The dynamics within private markets often favor fund managers over investors, due to inherent agency problems. These issues arise from the industry’s primary focus on managerial control and incentives, which can result in outcomes that disproportionately benefit fund managers at the expense of investors. Institutional limited partners (LPs) frequently accept the inefficiencies of private markets because they, too, manage funds on behalf of others, perpetuating a cycle of inflated fees and inadequate oversight.
Moreover, the mechanisms for replacing underperforming or unethical general partners (GPs) are often cumbersome, requiring a 75% approval from investors, which can entrench managers. Personal ties between LP executives and private equity firms further complicate accountability, as many senior LP representatives engage with GPs in various capacities, leading to potential conflicts of interest.
In theory, LPs should demand the same fiduciary standards from private capital managers that these managers apply to their own portfolio companies. However, in practice, the power dynamic heavily favors the managers, resulting in weak governance structures and limited protections for investors.
Some institutional investors have begun to recognize their diminished influence over fund managers and the excessive compensation drawn by these managers relative to their performance. As a result, several large LPs, including prominent pension fund managers, are reducing their commitments to external fund managers and instead building in-house alternative asset management capabilities.
The future of retail investors in private markets
A recent legislative initiative aims to provide retail investors with universal access to private capital. For example, in August, the Trump Administration enacted an executive order titled “Democratizing Access to Alternative Assets for 401(k) Investors,” marking a shift toward inclusivity in investment opportunities. Meanwhile, European regulators have also made strides, with the UK government lowering the minimum investment threshold in long-term asset funds to £10,000. The European Union has gone further, introducing a Long-Term Investment Fund product that has no minimum investment requirement.0
A recent legislative initiative aims to provide retail investors with universal access to private capital. For example, in August, the Trump Administration enacted an executive order titled “Democratizing Access to Alternative Assets for 401(k) Investors,” marking a shift toward inclusivity in investment opportunities. Meanwhile, European regulators have also made strides, with the UK government lowering the minimum investment threshold in long-term asset funds to £10,000. The European Union has gone further, introducing a Long-Term Investment Fund product that has no minimum investment requirement.1
