How the democratization of private equity is changing the investment landscape
Once the preserve of institutional money managers, private equity is slowly opening its doors to a new wave of individual investors. As the industry adapts to a new environment, this democratization is changing how investments are made.
Private markets have been one of the fastest-growing investment channels in recent years. According to a March 2024 McKinsey report, private market assets under management totaled USD13.1 trillion by June 30, 2023, having risen nearly 20% per annum since 2018. Dry powder reserves rose to USD3.7 trillion, the ninth consecutive year of growth.
Despite this strong performance, 2023 was a challenging year. Private equity (PE) fundraising, for instance, fell 15% to USD649 billion as a combination of higher financing costs, lower multiples and an uncertain rates and macroeconomic environment created a difficult backdrop for PE managers (See Figure 1.)
Fund managers were also on the road longer to raise capital: funds that closed last year were open for commitments for a record average of 20.1 months – significantly longer than the 18.7 months in 2022 and 14.1 months in 2018.
In these tougher conditions, new funding structures have taken root, giving PE general partners (GPs) new pools of liquidity to tap into and giving more investors an opportunity to access the asset class.
Structural innovation
Although high-net-worth individuals and wealthy families have long wanted to boost their allocation to private equity, it hasn’t always been easy. Investment vehicles are typically complex and minimum commitments are high, with long lock-up periods and capital calls.
Enter evergreen funds, which are open-ended private market funds that have gained traction particularly among private banking investors keen to invest in private equity. Investors in evergreen funds can typically seek liquidity from their position through redemptions, which are granted in monthly or quarterly instalments, offering investors a flexible and convenient way to play the asset class. They offer increased liquidity features, and a potentially greater overall utilization of capital compared to drawdown funds.
The minimum commitment amounts are also far more digestible, enabling more investors to build a diversified portfolio of private market investments from the get-go.
“This is really a huge breakthrough from the traditional way of PE investing,” said Vicky Yick, Head of Greater China Private Wealth at Partners Group who was speaking on CFA Institute’s Private Markets webinar series.
Partners Group launched its first evergreen fund in 2001 and now manages about 17 such funds with USD44 billion in assets. Many of its peers have also launched similar funds. “Investors have the choice of investing in multiple different private market asset classes in an evergreen format, which is a really big step towards the democratization of private market products,” added Yick.
But not all evergreen funds are the same. This means investors should ask themselves some critical questions before investing in an evergreen fund.
Yick argues that investors should consider if the fund has access to direct investments and secondary investments to ensure a steady deployment of capital. They should also look into the fund’s allocation policy to ensure evergreen investors are getting the opportunity to invest in the same assets as institutional investors in the fund.
Finally, they should question the underlying composition of the fund: is the vintage diversified enough with assets at the start of their value creation cycle, some in the middle, and some on the verge of exits?
“Those that are planned for exits are a great source of liquidity for meeting [new] investment needs and meeting redemptions at the same time,” added Yick.
Going wider
Evergreen funds are not the only tool being used by private equity firms to widen their access to capital. Many asset managers are considering other novel and tailored alternatives, including the use of sidecars, feeder funds and funds-of-private-funds that are available to retail investors through wealth manager channels, according to a report from Dechert.
This is driven by a growing population of wealthy investors who are diversifying beyond traditional public markets to enhance their returns and gain access to more sophisticated products.
Additionally, limited exit options mean institutional investors are struggling to recycle capital and allocate money to new funds. As a result, GPs are seeking other sources of liquidity, including from individual investors.
These newer products serve different purposes. Sidecar vehicles, for example, allow fund sponsors to raise flexible add-on capital without over-leveraging their portfolio. These sidecar vehicles can invest alongside the main fund in a portfolio, can be set up in advance of a specific investment opportunity or be deployed for additional follow-on investments.
Feeder funds, meanwhile, pool capital commitments from investors and invest these into an umbrella master fund that oversees the portfolio.
This can also be tailored to high-net-worth individuals, with feeders serving an as important bridge between the traditional high minimum capital requirements of standard PE funds and wealthy clients who want to access private equity investments.
Institutional and high-net-worth individuals can also park their money with private equity funds-of-funds, investment vehicles that hold shares in other funds rather than investing directly in stocks or other assets. The portfolio diversification on offer can help mitigate downside risks, while also giving investors access to a broad array of products.
All these vehicles typically have lower minimum investment thresholds and more liquidity than traditional private equity funds – opening the door to the “retailization” of the alternative investments industry.
The market is certainly moving in that direction. But the democratization of private equity remains a slow process, held back by regulation, illiquidity, the need to educate retail investors, and the reluctance of many fund managers – among other challenges. According to a 2023 survey by Mergermarket, 91% of PE executives expect democratization to impact fees. (See Figure 2)
While fundraising in the first half of 2024 remained slow, sentiment is changing as PE firms and aggressive corporates step out of the sidelines and start putting together M&A deals, IPOs and buyouts – setting the stage for a better 2025.
For example, in the first nine months of 2024, M&A volume globally jumped 18.8% year-on-year to USD2.5 trillion, with each quarter this year outperforming its respective quarter in 2023, according to Dealogic data. Buyouts rose by 38% year-on-year to USD456 billion, while the number of megadeals – or those valued at USD10 billion or more – reached 26 in the nine-month period, up from 21 a year earlier.
“It seems to be a tough market for exits and fundraising, but it’s actually a good time to invest,” said Grace Lee, Partner and Group Chief Operating Officer at Qiming Venture Partners speaking on the webinar. “Valuations are low, so investors can invest at a low valuation and wait for the market to mature before listing or selling the company.”
But given the competition among private equity firms to raise funds in what is still a tough environment, GPs that successfully leverage the enormous amount of wealth sitting with retail investors stand to benefit the most. The ongoing democratization of private equity could offer a win-win solution for all, creating a new channel for how capital is raised in the industry.
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