For a long time, only large investors have been able to make direct investments in companies. This is changing thanks to new laws and regulations. In his exclusive essay for finews.first Fabrizio Pagani explains how private investors can access private markets.

This article is published on finews.first, a forum for authors specialized in economic and financial topics.

For ordinary retail investors, the opportunity to invest in private markets (e.g. private equity and private debt funds) has broadly been off-limits. According to the Securities and Exchange Commission (SEC), «A private equity fund is typically open only to accredited investors and qualified clients. Accredited investors and qualified clients include institutional investors, such as insurance companies, university endowments and pension funds, and high income and net worth individuals».

Typically, ordinary savers are excluded. Indeed, similarly, restrictive rules apply to the majority of alternative investments.

«What was considered a temporary measure has become a long-term trend»

However, the combination of evolving economic and monetary conditions, market developments, new ambitious government policies and more open supervisory drives means the landscape is changing.

In June 2014 the European Central Bank (ECB) introduced negative interest rates – a first from a major central bank. Other central banks, such as the Bank of Japan, followed suit, while in the US rates stayed positive, but at historically low levels.

What was considered a temporary measure has become a long-term trend. Today we believe the consensus is for interest rates globally to stay negative or at depressed levels for some time. The effects and pressure on fixed income products are obvious. Yields have decreased and, in several instances, become negative.

«Meanwhile, governments have been keen advocates of channeling savings into domestic businesses»

It appears that basic fixed income products – previously long-term staples for ordinary savers – are losing their appeal. Monetary and economic conditions are pushing retail investors to search for new strategies which can offer better returns. This hunt-for-yield mentality has increased the appeal of private markets, where returns can be higher.

An allocation into private markets offers the potential for healthy diversification, with demand reflected by strong growth in the asset class; in the last ten years, alternative assets under management have more than tripled – from $3.1tn in 2008 to around $11tn in 2019.

Meanwhile, governments have been keen advocates of channeling savings into domestic businesses, particularly small and medium-sized enterprises (SMEs), and have devised policies accordingly.

«Policymakers view a less bank-centric economic system»

Treasury departments, especially in Europe, are eager to see domestic savings funneled towards financing the real economy in order to broaden and diversify funding sources. I believe policymakers view a less bank-centric economic system as an encouraging development at the point that it can provide tax breaks for individuals investing in the real economy.

As highlighted by the U.K. government, the U.K.’s Individual Savings Account(ISA) scheme provides favorable tax treatment for retail investors and has been progressively opened up to include alternative asset classes. Similar schemes exist in Italy and France. These programs are contributing to transforming «private individuals and households from passive savers into more active investors, thereby increasing the opportunities for improved long-term financial planning».

«Alternative investments have inherent characteristics»

In 2015, the European Union (EU) launched a new investment framework, the ELTIF (European Long-Term Investment Fund), which regulates private investment in non-UCITS funds, i.e. alternative products. ELTIFs can invest, with a long-term view, in equity and debt of EU-based SMEs, including unlisted companies, infrastructure, and real assets. These funds are conceived for retail investors, but with certain limits in an effort to provide protection to ordinary savers. For example, a private investor (with a portfolio below 500,000 euros) cannot invest more than ten percent of their portfolio into ELTIFs.

Alternative investments have inherent characteristics, e.g. illiquidity and type of risk, which must be considered when they are marketed to retail. Therefore, the supervisory authorities strive to establish adequate information and disclosure requirements and risk mitigation principles.

In the U.K., in response to certain cases of malpractice, the Financial Conduct Authority recently introduced a new category of «funds investing in inherently illiquid assets», subjecting them to additional requirements. In the U.S., in June 2019 the SEC launched a consultation on how to expand retail access to private markets.

«Asset managers and distributors have a responsibility»

I believe a balanced approach is being developed in Europe and in the U.S. to permit retail investors to access private markets. The right balance must be struck between facilitating funding the real economy and providing adequate protection for savers as the regulators and supervisors strive to establish the correct disclosure and risk management requirements.

Asset managers and distributors have a responsibility as well to comply with these requirements and ensure that these products are sold and marketed responsibly. Within this framework, I believe the scope for further product innovation seems wide and deep.

Fabrizio Pagani is an Italian economist. He is Global Head of Economics and Capital Market Strategy at Muzinich & Co. He is also non-executive Director of the Italian oil company, ENI. He has been Chief of Staff of the Italian Minister of Economy and Finance, Pier Carlo Padoan, and has been Head of the Sherpa Office of the Organisation for Economic Co-operation and Development (OECD) and Special Political Counselor to the OECD Secretary-General. Within the Letta Cabinet, he served as senior counselor and G20 Sherpa of the Prime Minister.

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