Private Equity Funds Want to Enlist the Millionaires Next Door

(Bloomberg Businessweek) -- Private equity funds have spent decades wooing pensions, universities, and other big-ticket investors. Now they have a new pool of untapped capital in their sights: mere millionaires and even ordinary savers in workplace retirement plans.

Private equity firms use debt to buy out businesses—everything from hotel chains to doctor’s offices to restaurants—and overhaul them before taking them public or selling them. They also run funds that invest in real estate and loans to companies. Part of their success comes from the steady flow of cash they receive from large investors willing to lock up their money, giving buyout managers the flexibility to take on deals that could require years to pay off.

Private equity funds run almost $5 trillion and are constantly on the lookout for more capital to put to work—and earn management fees from. Their fundraising has gone global, expanding to Asian sovereign wealth funds and Japanese insurers. The next frontier is wealthy households. According to a recent report from Capgemini SE, households around the world with investable assets above $1 million controlled $74 trillion in 2019, up from $46 trillion as recently as 2012. About 44% of that wealth—more than $30 trillion—is in the hands of “millionaires next door,” those with $1 million to $5 million.

The giant Blackstone Group Inc., with $649 billion under management, has said it wants half of new client assets to come from individuals. Over the past two years it’s doubled staff in its private wealth solutions team, which is focused on selling funds to individuals through private banks and other intermediaries, says Todd Myers, the unit’s chief operating officer. Similarly, Scott Nuttall, co-president of KKR & Co., said in a recent investor presentation that in the past several quarters, “about 10% to 20% of the money that we’ve been raising has been coming from individual investors.”

But private equity firms are still a long way from being able to pitch their products broadly to the everyday rich. While there are a handful of listed PE funds open for the average investor, the vast majority are difficult to access directly. Regulators around the globe remain wary of letting most people invest in funds that tie up savings in nonpublic companies with limited disclosure requirements.

People who want to take the plunge must get their heads around a new terminology, such as “capital call” and “internal rate of return.” Returns can hinge on when a fund started and whether it was able to find good investment deals at the time. Mary-Anne Daly, chief executive officer of U.K.-based wealth manager Cazenove Capital, says people should plan to invest in successive “vintages” over several years to average out the ups and downs of the economy.

Smaller investors generally need a middleman to open the door to buyout funds. In 2016, Steffen Pauls, a former KKR managing director, launched Berlin-based Moonfare, a digital private equity platform for individuals in Europe. Moonfare’s minimum investment is €50,000 ($60,675). That gets an investor into a “feeder” fund, which in turn puts money into buyout funds. At higher amounts, investors can choose specific funds. Moonfare charges a management fee of 0.5% of assets per year, which is on top of the fees the private equity managers charge. Rivals to Moonfare include Titanbay and Connection Capital in the U.K., as well as New York’s ICapital Network, which works through advisers instead of going directly to the investor.

Moonfare has about €870 million under management. Pauls says regulation was “the biggest obstacle we had to overcome” but adds that policymakers will come under increasing pressure to allow more access. Low interest rates have investors looking for sources of better returns, and Pauls argues that ordinary investors now miss companies’ fastest growth phase because firms stay private for longer. “There is a political need to open up these markets,” he says.

Ludovic Phalippou, an Oxford University professor and lecturer on private equity, says regulators and the industry need to standardize how fees and returns are reported before funds are offered to the mass market. Fees can be as much as four times those for a mutual fund, and the private equity industry’s favorite measure of performance, the internal rate of return, is not an easy-to-understand representation of how much money goes into investors’ pockets, he says. Phalippou has argued that private equity’s edge over public stocks is often exaggerated.

“I expect lawsuits when people realize they pay a lot more fees than on paper and realize the IRR is meaningless,” says Phalippou, who’s written papers analyzing fund returns. “I am, though, positive that if PE is open to ordinary investors, the regulators will force the industry to change the way it reports key metrics.”

Swiss-based private equity manager Partners Group Holding AG plans to “ramp up” efforts totarget 401(k) retirement plans as part of a broader effort to draw in U.S. investors, says co-CEO David Layton. Last year the U.S. Department of Labor issued a letter clearing the way for workplace plans to offer savers exposure to buyouts, as long as the investments are part of a diversified asset allocation fund. U.K. authorities have given a tentative nod to a similar initiative.

It’s unclear whether the Biden administration will be as friendly to opening up private equity. Senior Democratic lawmakers including Ohio’s Sherrod Brown and Massachusetts’ Elizabeth Warren are hostile to the industry, blaming it for piling debt onto struggling companies and laying off workers. They won’t be so eager to see more capital fed into the buyout machine.

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