Alternative Insight – September 2014

Falling subscription thresholds

This insight spotlights a rising trend of large US fund managers tailoring new funds for America’s broader retail investor class and questions whether Europe will follow where the Americans lead.

Dollars to dimes; Euros to cents?

Large U.S. alternative fund managers are trying crack the affluent retail investor market. Will European managers follow the same path?

David Rubenstein, co-founder of Carlyle, has predicted that the growth of commitments by individual investors to alternative asset funds will outpace that of public institutions like pension funds.

The minimum investment for funds sponsored by European alternative fund managers is typically €5m – could that soon drop to as little as €10,000? U.S. managers are targeting retail investors by reducing minimum subscriptions:

  • In May 2014, KKR and Altegris Advisors launched a similar type of PE fund, but with a minimum subscription of $10,000.
  • In 2013, Carlyle and Central Park Group launched a new fund with a minimum commitment of $50,000 aimed at U.S. “accredited investors” (basically, an individual with at least $1m in net assets, excluding personal residence).
  • A growing number of US mutual funds are now offering hedge fund strategies (eg, long/short plays, adding leverage) with minimum subscriptions of as little as $5,000.

Why is this happening?

  1. Deregulation in the U.S. – following the JOBS Act, the SEC has removed the ban on general solicitation, so long as the fund can verify that all of its investors are “accredited”. This has made it easier to publicise alternative funds to a wider audience.
  2. Pension funds – there is over $3 trillion sitting in America’s 401(k) definedcontribution plans, very little of which is currently directly allocated to alternatives. Although defined-benefit (DB) pension plans have allocated significant sums to alternatives in the last decade, they account for a declining share of pension funds’ AUM.
  3. Closed-ended funds harder to raise – most managers are looking for new sources of money as some traditional institutional investors recede from the market (especially banks and insurance companies due to regulation) and certain big LPs build out their own direct investment capability (eg, Canada’s CPP).

How are funds adapting to smaller investors?

Retail investors are generally more cashflow-sensitive than institutions, so managers are trying to improve secondary liquidity for funds aimed at the affluent investors:

  1. Redemptions – The KKR/Altegris fund (mentioned above) plans to institute limited, periodic share buybacks to offer LPs an exit after two to three years.
  2. Tradeable interests – A new secondary trading platform, the Nasdaq Private Market, is set to enable LPs to sell fractional interests in private funds that sign up to the market to other accredited investors (although it is not clear whether GPs will relinquish their long-standing power to restrict transfers without their consent).
  3. Listing the fund – For example, the New York Times reported in May 2014 that billionaire hedge fund manager William Ackman is planning to raise a new billiondollar closed-end fund with a listing on the London Stock Exchange.

Will European managers follow the U.S.?

In short, yes, but it will take time.

For the moment, the outreach to retail is mainly a U.S. phenomenon. European fund managers face the same challenges as their American counterparts, such as the shrinkage of their traditional DB investor base. There is also a large pool of European pension money that has yet to be tapped. The UK government’s recent decision to scrap compulsory annuities will give retail investors much more control over the use of their pension pots, some of which could be attracted by alternative funds.

EU regulators have not yet freed up constraints on general solicitation of the public by alternative funds. But the requirements to qualify as a sophisticated investor in certain European jurisdictions, like the UK, are less stringent than the U.S.

Aside from regulatory constraints, there are good reasons for alternative fund managers’ historical preference for institutional investors and HNWIs. Private funds generally don’t want to subject themselves to the regulatory scrutiny that characterises retail funds. Private equity funds, in particular, need deep-pocketed investors who can make large sums available at short notice for what may be quite illiquid investments that may not generate profits for several years. Adapting a fund’s structure and terms to accommodate smaller investors will therefore be key to competing for their money.


 

Alternative Insight is produced by MJ Hudson’s private funds lawyers. We provide expert legal advice to fund managers, other financial sponsors, investors and advisers on the formation, structuring, investment into and regulation of private funds, managed accounts and similar vehicles. Our practice covers the full spectrum of alternative assets, including private equity, venture capital, hedge funds, private debt, real estate and infrastructure. Clients praise our entrepreneurial approach, commercial outlook and dedication to helping them achieve their objectives, regardless of the obstacles.