NPM Alternatives, private equity, PE trading, NASDAQ">

Nasdaq courts advisers with new private-equity trading platform

Marketplace promises PE rarities: liquidity and lower investment minimums

Mar 8, 2017 @ 2:06 pm

By Jeff Benjamin

Private-equity managers are poised to start targeting financial advisers and their wealthier clients, thanks to an expanded alternatives platform by Nasdaq Private Markets.

Debuting Wednesday as NPM Alternatives, the private-auction marketplace will provide liquidity, lower investment minimums and lower investor net-worth requirements for private-equity investing.

No details yet exist on fees, as the platform is still awaiting the creation of products specifically designed for it, but the general idea is this represents a breakthrough for the private-equity space.

"If they can solve the liquidity issue with private equity, that's a home run," said Ed Butowsky, managing partner at Chapwood Investments.

"The idea of giving smaller investors more access to alternatives is exactly what is needed, because, mathematically, it's impossible to have an efficient portfolio without alternatives," he said. "As an investment strategy, I love the idea."

To be clear, the platform moves down market from qualified investors with a net worth of $5 million, to accredited investors with a net worth of $1 million. But this is still not aimed at retail-class investors.

The platform, which was years in the making and required special approval from both the Securities and Exchange Commission and the Internal Revenue Service, is considered a revolution in the $4 trillion private-equity marketplace, where regular liquidity is almost unheard of.

"This is going to make private-equity investing radically more accessible," said Bob Rice, chief investment strategist at Tangent Capital.

Mr. Rice, who is on the advisory board helping to develop the platform, is most enthusiastic about the prospects for what he calls "slow-motion ETFs," which will be SEC-registered portfolios of private-equity fund investments.

These yet-to-be created funds will trade on the exchange, similar to exchange-traded funds that rely on authorized participants to maintain tight spreads between the price of the funds and the price of the underlying investments.

Unlike ETFs, the traded PE funds will be restricted to accredited investors, and minimums are expected to be at least $10,000.

Liquidity will be monthly, which is a major improvement over the current PE market, in which lockups can start at five years and sometimes run beyond 15 years, or whenever the original investment is sold or taken public.

One of the main reasons private equity is typically so illiquid is because allowing investors to redeem requires cash, which means either selling portions of the portfolio or holding cash. Both of those options represent a potential performance drag on the portfolio.

By wrapping PE portfolios inside ETF-like funds, the underlying portfolios can stay fully invested because the portfolio is being traded, not the underlying investments.

The fund structure, which will be similar to registered investment companies operating under the Investment Company Act of 1940, also will remove a few other traditional PE-investing headaches such as calls to investors for extra capital, complex K-1 tax reporting and unrelated business income status, paving the way for investing through some qualified retirement accounts.

"Investors will have to be accredited, and the broker-dealer or adviser will have to certify that to Nasdaq," Mr. Rice said. "Basically, investors will have to go through an investment professional, so no robos allowed."

In addition to becoming a market for traded PE funds, the new platform is a secondary market for private-equity feeder funds, which are pooled assets to meet minimums to invest directly in a private partnership.

This is another breakthrough in terms of liquidity, but still not as liquid as the registered PE funds.

According to Eric Folkemer, head of Nasdaq Private Market, the trading volume of feeder funds will be limited to the equivalent of 10% of the fund per year, which compares to a prior rule limiting trading to 2% of the fund per year.

Staying within the trading limits is key, because violating the limit converts the entire private partnership into a public company for IRS tax purposes, which is the opposite of what most private-equity investors want.

Private-equity partnerships, similar to mutual funds, are pass-through entities that are not taxed at the fund level.

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