Managers of funds investing in private markets have come up with more creative vehicles to expand their investor base from large institutions to include wealthy individuals and families.
There were about 520 closed-end private-market funds catering to individual investors with a combined net-asset-value of at least US$350 billion at the end of last year, according to a late February blog post by Preqin, a London-based firm that provides data and analysis on private markets. That figure is likely conservative because only 427 of these funds disclosed their value, Preqin said.
One reason the private-market sector is shifting to private wealth is institutional appetite for alternative investments has weakened, and major fund managers need new sources of capital. According to a market overview released last week from Hamilton Lane, a Conshohocken, Pa.-based global private markets investment management firm, funds raised for new private-markets funds fell 35% from a peak of about US$1.6 trillion in 2021.
The drop in fundraising—to what is still a relatively high figure of a little more than US$1 trillion in 2023—reflects the difficulty private-equity funds are having in exiting positions in part because of a weak market for initial public offerings. Investors want to know they will get their capital back along with a substantial return.
“You’ve got a lot less liquidity coming out of private-equity funds than you had in the prior 10 years because the capital markets just aren’t receptive,” says Scott Conners, managing director and president of FlowStone Partners, a unit of the US$40 billion wealth management firm Cresset, based in Chicago.
Institutions also largely have full allocations to private markets and don’t need to invest more.
Private-wealth investors, who have only about 2% of assets allocated to private markets—according to the Hamilton Lane report—look like a good source of capital for filling the gap.
In contrast to private wealth, a 2023 study from the National Association of College and University Business Officers found the average endowment allocates 17.1% to private equity and 11.9% to venture capital. Research from BlackRock similarly found institutional investors in the U.S. allocated about 28% of their assets to private credit, private equity, infrastructure, and real estate.
The U.S. private-wealth market, meanwhile, was expected to reach US$58 trillion in assets under management, or AUM, last year, Hamilton Lane said.
“If we just look at the average U.S. private-wealth investor allocation, and it increased from 2% to 3%, that would add US$580 billion to the AUM of the private markets,” the report said. “That’s an increase in private markets AUM of more than 5%.”
That shift is likely to happen. A survey by Hamilton Lane of private-wealth investors found nearly 75% plan to boost their private-markets allocation this year.
The industry will likely take advantage of this sentiment “to fuel growth in various products and lines of business,” says Mario Giannini, executive co-chairman of Hamilton Lane. “What will happen as a result of some of that is that the largest of the private-market firms will continue to get larger.”
In its 2024 outlook report, Preqin also noted that large managers such as KKR and Blue Owl Capital, both based in New York, are likely to be the major players in this sector. KKR recently said that 15% of the capital it’s raised “in recent years,” has been from individuals, Preqin said, expecting that figure to reach 30% to 50%. Blue Owl Capital disclosed last year that it had raised more from individual investors than institutions last year, Preqin said
“While the private wealth channel has been on private equity managers’ radar for some time, it is safe to say that fundraising is now set to become a material part of the total,” the firm said.
The Continuing Rise of ’40 Act Funds
Innovations that have been developing over more than a decade are likely to continue fueling growth from the private-wealth sector. These include the rise of ‘40 Act funds, which are also called evergreen or perpetual funds. These vehicles, authorized via the 1940 Investment Company Act in the U.S., require lower investment minimums than traditional private-equity funds and allow a small percentage of investors to take cash out as often as quarterly instead of requiring them to lock up their capital for 10 years or more.
These funds also enable investors to put their capital to work right away instead of waiting for it to be called when a manager is ready to invest it.
One strategy these funds follow is investing in so-called secondaries, that is, investments owned by existing private-equity funds. It’s a sector of private markets that’s grown to about US$110 billion, according to Conners.
FlowStone Partners launched FlowStone Opportunity Fund in 2019 to invest primarily in this sector, although the fund also holds investments in newly launched private-equity funds “to create access to better quality managers that you don’t necessarily see on the secondary market,” Conners says.
The fund has grown from about US$57 million in assets in the first half of 2020 to about US$700 million in assets today, Conners says. Its three-year annualized returns through the end of last year were 12.21%, compared with a 10% return for the S&P 500.
The market for secondaries has grown as more institutional investors shed their private-equity investments. For the last couple years, capital calls from traditional private-equity funds seeking to invest in companies have exceeded the amount of capital their investors were getting back, he says.
“That’s been eating into their investment budgets,” Conners says. As a result, a private-equity fund that formed in 2017 is “probably going to have a two-year longer average life,” which is an outcome institutional investors hadn’t planned on.
To get their portfolios back in line, these institutional investors are selling their private-equity funds to secondary managers. These sales are typically at a discount, which makes them attractive to secondary-market investors.
FlowStone Opportunity owns 205 different funds that were formed as far back as 2005. Each of these funds owns multiple companies, adding up to about 1,600, Conners says. “It’s a very broad window on private equity,” he says. “It’s effectively an index.”
The minimum investment in FlowStone Opportunity ranges from US$100,000 to US$1 million, depending on the share class, which is still high (some funds have minimums as low as US$25,000), but it’s generally lower than the requirements for a standard closed-end private-equity fund which can run into multimillions.
Private-wealth investors are considering these kinds of funds as private markets have done better than their public counterparts over the last 15 to 20 years, Giannini says.
The challenge is even these relatively new semi-liquid evergreen structures aren’t as liquid as the public markets. You can’t buy and sell a share within a day or even a month. Generally, about 5% of a fund can be sold each quarter.
“Investors need to understand that,” Giannini says. “The question for everybody is, is there enough education going on that people understand how these can fit in a portfolio and what the pros and cons are? We’re very early in the process of that market getting used to it.”
