Carlyle Group, KKR and other private equity firms target individual investors with interval funds

Weighing the pros and cons of the new registered funds

Jun 23, 2016 @ 1:05 pm

By Jeff Benjamin

The powerful appeal of private equity investments has helped some of the biggest names in the space quietly move down market with products aimed specifically at individual investors, which presents some new challenges and opportunities for financial advisers.

Bluechip PE firms, including The Carlyle Group, KKR, and Partners Group, have started rolling out registered funds to give accredited individual investors exposure to an asset class that is considered one of the best sources of growth for pension funds.

The so-called interval funds are unique for private equity because they offer periodic liquidity in an asset class that is historically known for lock-up periods of between five and seven years.

There are currently less than a dozen of these funds on the market, with more already in registration.

Even though the funds are registered under the Investment Company Act of 1940, and some are also registered under the Securities Act of 1933, they should not be confused with traditional open-end mutual funds.

For starters, they are limited to investors with a net worth of at least $1 million, even though the minimum investments can start as low as $25,000.

Other key distinctions include higher fees and limited quarterly redemptions.

“You're on the road toward something that looks like a normal security, because its registered and there is some sort of liquidity,” said Bob Rice, chief investment strategist at Tangent Capital.

“Private equity has historically been the ultimate in illiquidity,” he added. “But as it's being brought into the mainstream there are more opportunities for advisers to put clients into an asset class that has historically represented the highest growth potential inside institutional portfolios.”

James Maloney, vice president of public affairs at the American Investment Council, described private equity investments as the “best-performing asset class inside defined benefit retirement plans over the past decade.”

Net of fees, he said private equity allocations inside defined benefit plans generated 12.2% annualized 10-year returns through June 2015, the most recent performance data available.

A large part of that performance advantage, according to Mr. Maloney, is tied to the trademark illiquidity that gives portfolio managers the ability to operate free of redemption fears or other cash-management-related challenges.

“The flexibility of the private equity model involves having patient capital that does not need to be deployed at any particular time,” he said.

Even though the registered interval funds might be luring investors with the promise of limited liquidity, it isn't likely to represent enough liquidity to radically hamstring portfolio managers the way managers might be effected in traditional open-end mutual funds.

Consider, for example, the Altegris KKR Commitments Fund, which has raised $130 million since its July 2015 launch.

The minimum investment is $25,000, and there is no liquidity for the first two years. After that the fund offers to tender 5% of the fund's assets on a quarterly basis.

“We keep telling investors, if they are looking for liquidity this is not the place to put your money,” said Jack Rivkin, chief executive and chief investment strategies at Altegris Investments.

The fund, which has a total expense ratio of 1.75%, is up net of fees 4.5% since inception, which compares to a decline of 1.7% by the S&P 500 Index over the same period.

“The average private equity fund has historically had an annualized premium over the public markets of between 3.5% and 4%, and I see no reason why that wouldn't continue,” Mr. Rivkin said. “Investors in public market buy and hope, activist investors buy and suggest, and private equity firms buy and fix.”

While it is true that private equity owners tend to be more actively involved in their various portfolio companies, including taking seats on corporate boards, the expectations of ongoing outperformance might be an overstatement.

“If you're wondering whether private equity is the right place to allocate assets right now you only have to look at the valuations in the public markets,” said Dick Pfister, founder and chief executive of AlphaCore Capital.

“There's been such a demand for private equity over the last five years that the valuations of private companies have ballooned up just like the public companies,” he added. “The PE firms have grown assets, as well, and they're just as susceptible to overpaying as the guys in the public markets.”

However, Mr. Pfister added, the PE managers have the advantage of being able to ride out markets fully invested because of the illiquidity provided the fund investors.

“Sometimes the illiquidity can help investors,” he said. “In a market selloff, if investors have liquidity they're be more likely to sell at the bottom.”

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