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Novel solutions to liquidity challenges of private markets puts individual savers on level playing field with institutional investors
The ability for retail investors to access private asset classes is becoming a reality. Dedicated strategies and products now exist in the wake of investor demand, real economy needs and regulatory encouragement.
As a result, private equity and other private assets are no longer the preserve of institutional investors. The resilience and long-term outperformance potential of private assets are now available to complement retail portfolios.
An overwhelming majority of all companies in all regions of the world are held in private hands and are therefore typically unavailable to individual portfolios, which tend to have allocations to more readily accessible listed securities only. This is the primary reason why private equity could be a meaningful addition to retail investors’ portfolios.
Many privately held companies are fast-growing, family-controlled, and/or require additional investments to reach the next step of development. The transition to private equity operators could turbo-charge both their growth and profitability.
Benoit de Kerleau, Managing Partner and Global Head of Strategy at Flexstone Partners, an affiliate of Natixis Investment Managers (Natixis IM), says: “French retail investors are looking for long-term wealth management strategies that have the potential for higher performance than traditional investments such as capital guaranteed funds, especially within life insurance contracts.”
The addition of private assets to a portfolio can also add diversification benefits, reducing overall volatility and downside risk.
However, typical life insurance contracts have no exposure to private equity today. de Kerleau says: “While private equity may always be additional to a portfolio, a meaningful allocation in contracts managed by life-insurance companies through unités de compte would be 4% (balanced) to 8% (dynamic) depending on individuals risk profile.”
Investment in real assets, which are supporting the real economy, is currently favoured by political and regulatory bodies in France and elsewhere in Europe.
In France, a series of laws has encouraged investment in energy transition infrastructure in particular. The Energy and Climate Act of 2019 set a goal of net zero emissions by 2050, and a 55% reduction in greenhouse gas emissions by 2030. This was followed by the Renewable Energy Acceleration Act in March 2023, which aims to speed planning procedures, cut red tape, and increase the availability of land for renewable energy projects.
Most recently, the Green Industry Law of October 2023, come into effect in October 2024, was conceived to decarbonize industry by offering investment incentives, slashing administrative delays, and strengthening environmental impact criteria, and facilitate French individual investment in private assets.
Most of the infrastructure required to comply with these laws will indeed be in the form of private assets. To assist with the financing of these assets, the forthcoming French rule for life insurance and retirement schemes demands they hold a minimum proportion of real assets in their default portfolios.
Pan-European regulations and fund structures are moving in favour of private assets too, with the relaunch of the EU’s European Long-Term Investment Funds (ELTIFs). ELTIF 2.0 provides a way for retail investors to tap into private markets on a large scale, by reducing minimum investment thresholds (down to 1.000€) and permitting funds of funds vehicles.
The key challenge that any retail strategy investing in private assets must address is liquidity.
In private markets, it can take time to sell a company and thereby to crystallise value and create cashflow. To date, this has meant that direct private equity strategies have been contained within closed-ended funds, featuring numerous and unplanned capital calls as and when investing in various opportunities. This format does not suit most retail investors.
An alternative cashflow pattern can be achieved, however, by using evergreen funds and investing part of a portfolio in secondary markets and co-investments opportunities, while holding minimum levels of cash. “Thanks to the evergreen structure, there is only one capital call – on Day One, and the investor is fully invested”, says de Kerleau. In addition, earlier distributions are achieved from the secondary holdings, that display shorter maturities, and offer flexibility for liquidity management, both through purchase and disposal of portfolios of private equity funds.
Communication between distributors and retail investors is paramount, however, as investors must be able to understand that while retail offerings in private markets may be UCITs-like, they cannot offer daily liquidity. In addition, short-term holding of private assets limits the benefits of long-term value creation.
Evergreen strategies offer permanent and regular access for retail investors, albeit with a few constraints.
Minimum subscriptions are in the thousands of euros, which is more than most UCITS funds, but considerably less than the minimum hundreds of thousands of euros thresholds set by closed-ended structures.
Redemptions and subscriptions are quarterly and there is an initial lock-up period, so these offerings are not totally liquid, but they are a far cry from the traditional model of close-ended funds with a 10 to 12 year lockup period and no liquidity until an asset is sold.
Flexstone Partners’ strategy is seeded by purchasing interest in private equity funds in the secondary market, thanks to capital provided by Natixis IM. In the case of significant new subscriptions, the strategy buys assets in the secondary market and investors buy units which reflect the value of the portfolio. After such ramp-up phase, investments are also made in primary funds on a regular basis.
The strategy is initially available in France through unit-linked insurance products, but the channels and platforms are likely to expand in France and across Europe over time.
Flexstone Partners’ retail strategy largely reflects its long-established institutional offering. Both have a core, resilient portfolio of primary investment, completed by secondaries and co-investments to reduce the J-curve effect traditionally affecting the performance of private equity funds. (the “J-curve” refers to the cash flow profile of most private markets investments, when capital calls in the early days of the fund imply negative returns for the investors before the investments made by the fund in the long term generate positive returns, creating overall a J-shaped returns curve).
There is a focus on small and mid-cap companies to decorrelate performance from listed markets and larger private equity strategies. In terms of risk, it is highly diversified in terms of geography, strategy, General Partners and sectors.
De Kerleau says: “We manage risk for retail investors in the same ways we have done for institutional clients for 20 years. This starts with disciplined selection, then diversifying assets by sector, geography and strategy type.”
Flexstone Partners’ 60-strong team across Europe, the US and Asia facilitates geographical and sector diversification, while its sourcing capabilities allow it to allocate to all private equity segments – primary, secondary and co-investments. It further diversifies across vintages to ensure that the investment cycle does not skew the returns from a particular vintage.
Excluded from the retail strategy are riskier private equity segments, such as venture capital or turnaround funds - which can be volatile – with a preference for growth and buyout.
In addition to illiquidity, complexity is another risk that individuals investing in private equity should consider, even if using an evergreen vehicle.
“Despite the liquidity offered, we would recommend at least an eight-year holding period to benefit from the long-term value-add of private equity,” de Kerleau says. “It takes time to create value in the real economy, as opposed to in listed securities, where performance is based partially on investor sentiment.”
Typically, long-term operational improvements in the underlying assets include expanding the range of products and markets for new or existing products, strengthening management teams, and improving strategy and marketing to get to the next level.
The target is to create at least 10% to 12% increase in the net asset value yearly across the private equity portfolio over the long term.
As an asset manager, technical excellence in all of the private equity segments and strategies is required to create a resilient, balanced and diversified private equity portfolio that is suitable for retail investors.
Access to the most sought-after private equity managers is key to such portfolio construction, and it has been the core focus of Flexstone team, with 60 seasoned professionals across 4 offices in the world (Paris, Geneva, New York and Singapore) over the last 20 years.
Flexstone Partners
An affiliate of Natixis Investment Managers
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