SEC director calls for private markets to open up for retail investors

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A top US investment industry regulator has called for pension savers to be granted greater access to private markets in a push that would ease the path for ordinary investors to increase their exposure to riskier strategies.

Dalia Blass, director of the Securities and Exchange Commission’s investment management division, said last week that main street investors had been left “on the outside looking in” because defined contribution pension plans did not provide access to private investments such as private equity, hedge funds and real estate.

“Private investments have the potential to provide stronger returns and diversification for investors, but come with both performance and liquidity risks,” Ms Blass said.

Target date funds and closed-end funds could provide convenient routes for pension savers to invest in private markets, she added.

Assets held in target date funds stood at $2.3tn at the end of 2019, according to Sway Research, a New Hampshire-based consultancy.

Vanguard, which is the largest provider of target date funds, agreed in February to form a strategic partnership with HarbourVest, a $68bn private market specialist, to provide access to private equity to qualified investors with a net worth of at least $1m.

Private equity managers have lobbied the US government for years for permission to sell their strategies to the US’s $7.9tn defined contribution pension market where the responsibility for ensuring an adequate income in retirement sits with an individual worker and not the employer.

Closed-end funds do not offer daily redemptions and some already hold illiquid private investments but relatively few of these vehicles exist. SEC staff have historically been concerned that closed-end funds with significant holdings of private assets are not suitable for retail investors, a position that is now under review.

Ms Blass’s comments suggest SEC leaders may have been persuaded that ordinary pension savers and wealthy individuals should be permitted to invest in private markets. But her speech also points to the ongoing tensions inside the regulator over proposed changes in policy.

SEC staff produced a critical report in June detailing “deficiencies” in the behaviour of private equity and hedge fund managers, leading to numerous instances where sophisticated institutional investors overpaid for services.

Erik Gerding a law professor at the University of Colorado University said successful private equity managers would not want to deal with retail investors as they preferred working with institutions that could write large cheques.

“Retail investors will be left with the worst offerings from the bottom of the barrel while the best opportunities will go to institutional investors. These changes will not help retail investors earn better returns but they will provide private equity managers with fresh meat.” 

Tyler Gellasch, executive director of Healthy Markets Association, a trade group, said more ordinary investors would be exposed to greater risks and higher fees by the determination of the SEC Commissioners to expand access to private markets.

“The proposals increase the risk of a mis-selling scandal,” said Mr Gellasch.

The SEC has asked market participants to provide their views on how closed-end funds that provide access to private markets could be structured to reduce risks and to avoid extra layers of fees and expenses being charged to retail investors.

“The underlying investments in DC plans need to evolve to improve retirement incomes for their members,” said Angela Antonelli, executive director of the Center for Retirement Initiatives at Georgetown University’s McCourt School of Public Policy.

Many DC plan sponsors had a “myopic focus” on low fees, which had severely reduced the investment options to boost returns for pension savers, said Ms Antonelli. 

The Department of Labor said for the first time in June that private equity could be used in the professionally managed funds sold to retirement savers. Private equity managers could gain as much as $400bn in new assets from the DoL rule change, according to analysts at Evercore.

“The strategic use of alternative assets in a target date fund structure can improve expected retirement incomes and mitigate losses in downside scenarios,” said Ms Antonelli.

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