Where opportunity meets responsibility
Examining the implications of the SEC expanded definition of an 'accredited investor' for private equity investors — and the advisers who serve them
The SEC’s recent decision to increase individual access to private equity by expanding its definition of “accredited investor” has generated predictable objections from investor watchdogs. At Baird, we think it’s sound public policy — but would remind everyone that with expanded opportunities comes expanded responsibilities for investors and financial advisers alike.
The SEC’s action prioritizes investor choice and expands investment opportunities at a time when market conditions don’t necessarily favor individual investors. Public equity markets are fully valued and concentrated among a handful of mega-cap companies. The number of publicly traded companies continues to decline steadily from its peak in the late 1990s. Bond yields are at their lowest point in our lifetimes. Cash is generating a negative real rate of return.
For investors struggling with these challenges, private equity offers an alternative to traditional investment channels.
This isn’t a secret to institutional investors, who are facing the same obstacles and have been steadily increasing their allocations to private equity over the past decade. According to a 2020 report by Preqin, 81% plan to maintain or increase their allocation to alternative investments over the long term, with private equity showing the largest gains in planned increases.
So what’s the downside of allowing more investors access to private equity?
As with any other investment, it comes down to suitability, education and tactics.
By expanding the definition of “accredited investor,” the SEC acknowledged that income level ($200,000) and investible assets ($1 million) weren’t in and of themselves sufficient indications of whether private equity investments are suitable for any given investor. But even with an expanded definition, private equity isn’t right for everyone. With increased access to private equity comes the need for investor education. Unlike public equity, private equity invests through negotiated transactions in less efficient markets. That creates opportunities as well as risks.
“Following the SEC’s recent action, the suitability question is more important than ever,” says Katie Schoen, vice president of Baird Capital, Baird’s private equity group. “It’s imperative that investors take the time to truly understand the investment vehicle and vet the funds and managers so they can make an informed decision about whether private equity is a good investment choice for them.”
Perhaps the most critical question for would-be private equity investors is, “Are you in a position to tie investment dollars up for five, seven, even 10 years?” If you might need your money sooner, private equity may not be for you.
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Diversification is just as critical in private equity as it is in public markets. Funds, which make multiple investments, often have a reduced risk profile compared to individual investments. Experienced private equity investors decide on a target allocation for their portfolio, then invest and reinvest consistently to maintain that allocation over time.
Manager skill is equally important in private equity and the public markets. However, the risk differential is arguably steeper in private equity, where a firm’s success hinges on its manager’s ability to choose high-quality companies and take a significant, fairly illiquid ownership stake.
The SEC’s revised definition also creates new responsibilities for advisers, who must play a role in helping investors understand the traits, opportunities and risks inherent to private equity investing. Developing a process, identifying resources to evaluate private equity products and managers, and supporting educational discussions with clients are “must- haves.” Private equity is one area where quality advice can make all the difference for the client, underscoring the value of a strong, long-term relationship with a trusted adviser.
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John Taft is vice chairman of Baird and former chairman of the Securities Industry and Financial Markets Association.
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