Just two years ago, non-traded real estate investment trusts and business development companies were in favor among retail investors seeking increased opportunities for yield. Since then, a combination of increased regulatory complexity, negative media scrutiny and changing market conditions have caused many retail financial advisers and their clients to step away from these investments.
Many of the same forces are currently impacting energy-related programs targeted at the accredited investor (generally those with income over $200,000 per annum or an investable net worth of at least $1 million) with similar results.
But the very conditions that drove demand for income-generating or total return-oriented retail alternatives — such as an exceptionally low interest rate environment, creating a yield-starved investing landscape — remain fundamentally unchanged.
And that's where private equity comes in. With non-traded REITs and BDCs facing decreased investor demand, a number of companies specializing in private equity — a mainstay among institutional investors for decades — see an opportunity to capture market share among retail investors.
While there are plenty of reasons private equity could become a positive force in the retail alternatives space, not all private equity sponsors are created equally.
Broker-dealers and their financial advisers need to ask the following top three questions when considering whether it makes sense to do business with a private equity sponsor:
1) Is the private equity product sponsor willing to customize products for accredited mass affluent retail investors? Obviously, private equity has long been attractive to ultra-high-net-worth clients and large institutional investors. But developing products focused on the broader, but still accredited, retail investor segment is a different skill set. Product sponsors must have the willingness to customize products that will offer these mass affluent retail clients, including qualified purchasers (investors with $5 million or more in investments), the combination of income, transparency and liquidity they need in order to make progress toward their financial goals.
2) What kind of track record does the private equity sponsor have? Since private equity is a comparatively new area for the retail space, broker-dealers, RIAs and their affiliated financial advisers must carefully distinguish between the established players that have been offering these products for years versus newer entrants into the space. Beyond year-over-year returns, consider how long providers have been offering private equity products overall. In our view, private equity will only become more prevalent over time. However, we need to be aware that sometimes opportunistic players enter the retail alternatives market simply to take advantage of the latest retail investor trends. For the adviser, this is where working with a broker-dealer or RIA that has a lengthy history of performing robust due diligence on a wide spectrum of retail alternatives can be crucial.
3) What are the private equity sponsor's financial adviser compensation models? For brokerage products, are adviser payouts predominantly front-end loaded or do they reflect a longer-term horizon? The answer might indicate how committed the private equity sponsor truly is to the retail investor space. The private equity sponsors who are willing to structure payouts that strike a balance between up-front adviser payouts and a longer-term schedule of compensation are probably the ones that really intend to engage with the retail investor space for the long haul. This kind of structure also puts advisers in closer alignment with their more affluent clients.
One unintended consequence of recent industry regulatory pressure is that there are fewer alternative asset choices for mass affluent investors.
When the mass affluent investor has fewer options to potentially generate income in retirement or drive greater net worth, financial planning for pre-retirees and retirees becomes all the more complex — not less, as many regulations might lead you to believe.
Private equity vehicles could provide financial advisers with a helpful new tool, but caveat emptor for the broker-dealer/RIA and the financial adviser alike: Ask the right questions before doing business with a product sponsor in what remains an emerging new space for the broader retail investor community.
Clive Slovin is president and CEO of The Strategic Financial Alliance, a privately owned independent broker-dealer and registered investment adviser based in Atlanta.