How To Take Advantage of Private Market Investing

Individual investors — often called “retail” investors — are wielding more power in the public markets than ever before.

A flurry of innovation from the past couple of decades (low-fee index funds, no-fee trading, gamified mobile investing apps, etc.) has given millions of new investors a firm foothold in a world previously dominated by massive institutions, often literally moving the market in the process.

There’s just one problem: the stock market isn’t where institutional investor portfolios have had the biggest advantage over individual investor portfolios.

It’s the world of private market assets (think: private equity, venture capital, commercial real estate, etc.) where pension funds, endowments, and sovereign wealth funds have continued to sow billions of dollars annually while individual investors are left on the sidelines.

A solution to that problem appears to be imminent, though. Companies like Fundrise, aimed specifically at opening the private markets to individual investors, are growing rapidly and their customers are beginning to build institutional-esque portfolios.

Why institutional investors love the private market

The institutional investor’s love affair with the private market has only grown more intense over the years. According to McKinsey & Company:

• Private market assets under management (AUM) grew by $4 trillion in the past decade, an increase of 170%, and hit an all-time high of $6.5 trillion at the end of 2019. The global public market AUM has grown by only around 100% during the same period.
• Private market real estate saw $103 billion invested in 2019 in the U.S. alone, rising 24% versus 2018.

The attraction to the private market is relatively easy to explain, too: there’s a long-held conviction that private assets will outperform public ones over the long term. Or, as BlackRock (the world’s largest asset manager) explains, “The need of investors for return, income, and diversification brought private assets to their current prominence.”

Private market assets aren’t traded, which means they’re often less volatile. They’re less transparent and harder to properly value, which can lead to pricing inefficiencies and higher potential for market-beating returns. They also uniquely benefit patient investors with multi-decade time horizons who are willing to sacrifice the liquidity of the public markets for potentially better long-term returns.

The McKinsey Global Institute (MGI) estimates that U.S. bonds will yield only 0-2% over the next 15 years (after staying closer to 5-6% over the past 30 years). The same study showed that U.S. and European equities (i.e. stocks) are expected to range between 4-6.5% over the next 15 years. So in light of that level of potentially heavily-diminished public market returns, it’s no wonder the money has continued to pour into the private markets.

But “return, income, and diversification” are universally attractive investment features. Individual investors can be patient investors with multi-decade time horizons, too. So why have retail investor portfolios fallen so far behind?

Explaining the gap between individual and institutional portfolios

The disparity in portfolio allocation between institutions and individuals can be explained by a number of factors, including outdated regulation, misaligned incentives, and inaccessible minimums.

• Until 2012, there were strict net worth restrictions that prevented even relatively wealthy, “accredited” investors from investing in most private investments.
• The minimum investment in private equity funds is typically high — often around $25 million, although some are as low as $250,000.
• Private asset managers traditionally charge exorbitant fees, with sales commissions, servicing fees, management fees, and performance-based fees all part of the norm.

Perhaps most critically, though, the gap exists because the world of private asset management is optimized specifically for institutional investors, not individuals. To this point, they’ve “followed the money” to the tune of trillions of dollars in AUM. This led to the current state of affairs where retail investors are either implicitly or explicitly denied the opportunity to order off the same menu of investment options as their institutional counterparts.

It’s also what made the private asset management industry so ripe for disruption.

The rise of the private market retail investor

The democratizing effect of the internet seems to find its way into every industry sooner or later. Sure enough, the tech-driven transformation of the public markets is beginning to bleed into the private markets as well.

Fundrise, a DC-based real estate investment platform, is one of the prominent new companies leading the revolution. Back in 2012, Fundrise was the first U.S. company to successfully “crowdfund” a private commercial real estate project using only individual investors. Today, Fundrise uses its technology-driven platform to offer investors direct, low-cost access to a diversified portfolio of institutional-caliber real estate investments.

Fundrise now manages more than $1 billion on behalf of 150,000+ individual investors. Fundrise has also transacted on more than $4.9 billion worth of real estate and generated net average annual platform returns of 8.7-12.4% since 2014.

It’s remarkable that, after decades of sitting on the sidelines, hundreds of thousands of retail investors are now investing in the same type of investments that were once reserved for sovereign wealth funds — without minimum net worth restrictions, at low cost, and at the touch of a button on their mobile device. And this may be just the beginning.

Regulation has continued to prevent retail investors from investing in private market assets via their 401(k) retirement accounts (which collectively hold nearly $6 trillion in AUM). However, the U.S. government has recently begun to explore a rule change that would enable retail investor retirement funds to expand into the private markets.

Earlier this year, Dalia Blass, director of the investment management division at the SEC, stated that “main street investors [have] been left ‘on the outside looking in’ because defined contribution pension plans [like 401ks] did not provide access to private investments such as private equity, hedge funds, and real estate.”

Meanwhile, in June, the Labor Department issued regulatory guidance that allows retirement-plan sponsors to allocate to mutual funds that invest in private equity. This still bars 401(k) vehicles from making direct investments in private-equity funds, but nonetheless the first domino has fallen.

And so the rise of the retail investor continues.

 

*Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections may not reflect actual future performance. All securities involve risk and may result in partial or total loss. While the data we use from third parties is believed to be reliable, we cannot ensure the accuracy or completeness of data provided by investors or other third parties. Neither Fundrise nor any of its affiliates provide tax advice and do not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Neither Fundrise nor any of its affiliates assume responsibility for the tax consequences for any investor of any investment. The publicly filed offering circulars of the issuers sponsored by Rise Companies Corp., not all of which may be currently qualified by the Securities and Exchange Commission, may be found at fundrise.com/oc.

 

Citations: 

• https://www.mckinsey.com/~/media/mckinsey/industries/private%20equity%20and%20principal%20investors/our%20insights/mckinseys%20private%20markets%20annual%20review/mckinsey-global-private-markets-review-2020-v4.pdf

• https://www.sec.gov/spotlight/sbcfac/expanding-retail-access-to-private-markets-finley.pdf