Market Update 2/13/25: The Downside of Investment Democratization
Market Commentary
Jack Ablin
By Jack Ablin, Chief Investment Officer. Subscribe for weekly market updates.
Key Observations:
Less than two per cent of individual investor wealth is currently allocated to alternatives; that number will continue to rise sharply
Interval funds offer private investment access for retail appetites
But retail interval funds have return, valuation, and redemption negatives
We recommend investors who can tolerate illiquidity stick with smaller, closed-end partnership vehicles in private equity and real estate
The nation’s largest private investment managers see opportunity in bringing strategies once only available to institutional and other sophisticated investors down market to retail investors. Over the last several years, the largest private market firms, like KKR, Apollo and Blackstone, have been aggressively expanding into retail wealth management channels. The total personal wealth market is estimated to be about $178 trillion, according to Bloomberg; of this, approximately $80 trillion is held by individuals with at least $1 million investible. Currently, only about one to two per cent of individual investor wealth is allocated to alternatives vs one-third for institutional portfolios. By 2028, financial advisers are expected to be managing $3.6 trillion in alternatives for their individual clients, up 50 per cent from $2.3 trillion in 2023, according to Cerulli data. What are the implications of this trend for investors and markets?
Interval Funds Offer Private Investments for Retail Appetites
Tailoring private investing to retail individual appetites requires some adjustments because individual investors are more comfortable with tradable stocks and bonds than private investments requiring multi-year holding periods. Private equity is illiquid, requiring investors to hold for at least five years and often much longer. While retail investors are accustomed to watching their portfolio values float from minute to minute, private investments are valued quarterly at most and sometimes annually or longer, and are likely to be one quarter in arrears.
As a result, private market managers have launched new fund structures to make private investments more palatable for individual investors. Interval funds – open ended-fund vehicles that reopen quarterly – have emerged offering periodic liquidity and lower minimums. While traditional private equity funds require between a minimum of $250,000-1,000,000 to participate, interval fund minimums can be as low as $25,000-50,000. Interval funds structured as a regulated investment company (RIC) issue 1099 tax statements, similar to mutual funds, rather than K-1 partnership reports that often force investors to file extensions. Interval funds have as a sector has grown almost 40 per cent per year over the last decade and have attracted more than $35 billion by addressing some of the negatives associated with traditional private equity funds, like K-1s and capital calls. Morningstar now tracks 100 interval funds with combined assets of more than $80 billion, up from only 14 funds with combined assets $2.9 billion a decade ago.
Retail Interval Funds Have Return, Valuation, and Redemption Negatives
Interval fund structures sold to retail investors not accustomed to holding private investments, particularly long-term, illiquid assets like private equity and real estate, carry several negatives. By allowing fundholders to redeem a portion of their holdings quarterly, interval fund managers are forced to hold lower-returning higher liquid assets, like cash, to accommodate shareholder inflows and outflows. A quarterly valuation cadence is difficult and can sometimes lead to distortions. In 2022, for example, when REITs (publicly traded real estate) lost a quarter of their value, two high-profile interval funds marked their assets four per cent higher that year, causing a run for the exits. Shareholder redemptions persisted for several quarters and forced managers to sell real estate assets in the secondary market at appreciable discounts, hurting fundholders’ returns. Even though interval funds only allow redemptions of up to five per cent of assets per quarter, retail holders, not accustomed to illiquidity, could try to rush for the exits in market downturns. If closed-end fund performance is any indication, fearful investors in periods of stress happily unload their shares significantly below net asset value to get liquid.
Capital Deployment Pressure Challenges Investment Discipline
Market structure is another consideration. Private market firms will likely face significant challenges deploying capital after having raised substantial funds. KKR increased deployment to $84 billion in 2024, up from $44 billion in 2023, while Apollo is targeting $200-250B in annual originations over five years. As the largest private equity and real estate firms successfully raise billions of dollars of capital from retail investors through sophisticated distribution channels, like brokerage firms, they will be incentivized to invest capital quickly, creating tension between deploying committed capital and maintaining investment discipline. Meanwhile, a muted M&A environment is exacerbating large buyout challenges and high valuations are making attractive entry points difficult. Even though institutional fundraising has slowed, increasing retail capital adds to deployment pressure, making it harder to find deals that can generate attractive returns.
A misalignment of incentives to allocate capital will likely weigh on subsequent fund returns to retail investors. US buyout delivered 10+ per cent annualized returns between 2014 and 2023, roughly in line with the S&P 500. While private equity has held its own against public markets in recent years, risk-adjusted returns have been falling as private equity managers, particularly in the mega-cap space, have increasingly relied on leverage to boost investor returns.
Bottom Line
The democratization of private investments creates new risks, but it also presents interesting opportunities for high net worth and ultra-high net worth investors comfortable with illiquidity. We recommend investors who can tolerate the illiquidity stick with closed-end partnership vehicles in private equity and real estate. Interval structures still work for private credit, given their strong cash flow and shorter time horizons. We also recommend investors avoid investing in large-scale assets preferred by the largest private investors since the cascade of retail capital will crimp return opportunities. Instead, investors should focus on smaller assets, like middle-market private equity, for example. In the meantime, we will be on the lookout opportunities to create liquidity for retail investors willing to sell their interval fund shares at a discount in the secondary market. Notwithstanding the concerns, private market managers are ploughing ahead into the retail market.
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About Cresset
Cresset is an independent, award-winning multi-family office and private investment firm with more than $65 billion in assets under management (as of 1/15/2025). Cresset serves the unique needs of entrepreneurs, CEO founders, wealth creators, executives, and partners, as well as high-net-worth and multi-generational families. Our goal is to deliver a new paradigm for wealth management, giving you time to pursue what matters to you most.
Market Update 2/13/25: The Downside of Investment Democratization
By Jack Ablin, Chief Investment Officer. Subscribe for weekly market updates.
Key Observations:
The nation’s largest private investment managers see opportunity in bringing strategies once only available to institutional and other sophisticated investors down market to retail investors. Over the last several years, the largest private market firms, like KKR, Apollo and Blackstone, have been aggressively expanding into retail wealth management channels. The total personal wealth market is estimated to be about $178 trillion, according to Bloomberg; of this, approximately $80 trillion is held by individuals with at least $1 million investible. Currently, only about one to two per cent of individual investor wealth is allocated to alternatives vs one-third for institutional portfolios. By 2028, financial advisers are expected to be managing $3.6 trillion in alternatives for their individual clients, up 50 per cent from $2.3 trillion in 2023, according to Cerulli data. What are the implications of this trend for investors and markets?
Interval Funds Offer Private Investments for Retail Appetites
Tailoring private investing to retail individual appetites requires some adjustments because individual investors are more comfortable with tradable stocks and bonds than private investments requiring multi-year holding periods. Private equity is illiquid, requiring investors to hold for at least five years and often much longer. While retail investors are accustomed to watching their portfolio values float from minute to minute, private investments are valued quarterly at most and sometimes annually or longer, and are likely to be one quarter in arrears.
As a result, private market managers have launched new fund structures to make private investments more palatable for individual investors. Interval funds – open ended-fund vehicles that reopen quarterly – have emerged offering periodic liquidity and lower minimums. While traditional private equity funds require between a minimum of $250,000-1,000,000 to participate, interval fund minimums can be as low as $25,000-50,000. Interval funds structured as a regulated investment company (RIC) issue 1099 tax statements, similar to mutual funds, rather than K-1 partnership reports that often force investors to file extensions. Interval funds have as a sector has grown almost 40 per cent per year over the last decade and have attracted more than $35 billion by addressing some of the negatives associated with traditional private equity funds, like K-1s and capital calls. Morningstar now tracks 100 interval funds with combined assets of more than $80 billion, up from only 14 funds with combined assets $2.9 billion a decade ago.
Retail Interval Funds Have Return, Valuation, and Redemption Negatives
Interval fund structures sold to retail investors not accustomed to holding private investments, particularly long-term, illiquid assets like private equity and real estate, carry several negatives. By allowing fundholders to redeem a portion of their holdings quarterly, interval fund managers are forced to hold lower-returning higher liquid assets, like cash, to accommodate shareholder inflows and outflows. A quarterly valuation cadence is difficult and can sometimes lead to distortions. In 2022, for example, when REITs (publicly traded real estate) lost a quarter of their value, two high-profile interval funds marked their assets four per cent higher that year, causing a run for the exits. Shareholder redemptions persisted for several quarters and forced managers to sell real estate assets in the secondary market at appreciable discounts, hurting fundholders’ returns. Even though interval funds only allow redemptions of up to five per cent of assets per quarter, retail holders, not accustomed to illiquidity, could try to rush for the exits in market downturns. If closed-end fund performance is any indication, fearful investors in periods of stress happily unload their shares significantly below net asset value to get liquid.
Capital Deployment Pressure Challenges Investment Discipline
Market structure is another consideration. Private market firms will likely face significant challenges deploying capital after having raised substantial funds. KKR increased deployment to $84 billion in 2024, up from $44 billion in 2023, while Apollo is targeting $200-250B in annual originations over five years. As the largest private equity and real estate firms successfully raise billions of dollars of capital from retail investors through sophisticated distribution channels, like brokerage firms, they will be incentivized to invest capital quickly, creating tension between deploying committed capital and maintaining investment discipline. Meanwhile, a muted M&A environment is exacerbating large buyout challenges and high valuations are making attractive entry points difficult. Even though institutional fundraising has slowed, increasing retail capital adds to deployment pressure, making it harder to find deals that can generate attractive returns.
A misalignment of incentives to allocate capital will likely weigh on subsequent fund returns to retail investors. US buyout delivered 10+ per cent annualized returns between 2014 and 2023, roughly in line with the S&P 500. While private equity has held its own against public markets in recent years, risk-adjusted returns have been falling as private equity managers, particularly in the mega-cap space, have increasingly relied on leverage to boost investor returns.
Bottom Line
The democratization of private investments creates new risks, but it also presents interesting opportunities for high net worth and ultra-high net worth investors comfortable with illiquidity. We recommend investors who can tolerate the illiquidity stick with closed-end partnership vehicles in private equity and real estate. Interval structures still work for private credit, given their strong cash flow and shorter time horizons. We also recommend investors avoid investing in large-scale assets preferred by the largest private investors since the cascade of retail capital will crimp return opportunities. Instead, investors should focus on smaller assets, like middle-market private equity, for example. In the meantime, we will be on the lookout opportunities to create liquidity for retail investors willing to sell their interval fund shares at a discount in the secondary market. Notwithstanding the concerns, private market managers are ploughing ahead into the retail market.
About Cresset
Cresset is an independent, award-winning multi-family office and private investment firm with more than $65 billion in assets under management (as of 1/15/2025). Cresset serves the unique needs of entrepreneurs, CEO founders, wealth creators, executives, and partners, as well as high-net-worth and multi-generational families. Our goal is to deliver a new paradigm for wealth management, giving you time to pursue what matters to you most.