Democratisation refers to granting access to alternative strategies, such as private equity or real estate strategies, to non-professional investors.
For asset managers, it is perceived as a promise to unlock a vast pool of capital; for investors, it is a key toward higher alpha in their portfolio allocation.
The global real economy is also expected to benefit from this significant source of funding in a context of scarcity and increasing interest rates.
Democratisation refers to granting access to alternative strategies, such as private equity or real estate strategies, to non-professional investors.
Obstacles on the way to democratisation
EU regulatory framework: Access to retail investors in the EU is limited by the scope of the “marketing passport” under AIFMD and depends on the conditions set out by each Member State.
Although the European Parliament had initially proposed that AIFMD II extends the “marketing passport” to investors committing a minimum of €100,000, it has finally been withdrawn from its proposed text.
Understanding of alternative strategies: Because alternative investments involve sophisticated products, retail investors often lack the necessary expertise to assess the scope of their obligations and the inherent risks. In addition, the private funds industry tends to lack experience in dealing with non-professional investors and assessing the adapted level of explanation on complex strategies and structures.
Reshaping the industry model: The alternative fund industry infrastructure has not been conceived to address the volume and the specificities of non-professional investors. Designing dedicated operational, legal pricing and distribution models is critical to gain confidence and attract such investors on the long run.
Tracing the route towards democratisation
Relying on existing structures: The largest managers have already implemented structures to enlarge their investors’ base such as feeder structures, discretionary management mandates or asset-linked insurance policies. However, this often remains limited to investors having access to private bank relationships. In addition, evergreen, semi-liquid vehicles have emerged to address retail investors concerns with features such as smaller entry tickets or reduced number of capital calls. However, such products remain generally limited to clubs of happy few.
ELTIF 2.0: THE game changer? In the democratisation spotlight is ELTIF 2.0 which will soon enter into force. The original regulation missed this goal despite a purpose-tailored passport-based distribution framework granting access to both professional and retail investors. Lesson learnt: ELTIF 2.0 tackles inefficiencies of the previous regime. Fund managers are now being granted the tools, and time will tell if there is a willingness to embrace this opportunity or if the ELTIF will remain a niche product.
Financial education and transparency as keys: Financial education and transparency are the keys to unlock barriers to the rise of a finance republic. A comprehensive and intelligible fund documentation must allow targeted investors to fully understand the features of the alternative product (e.g., capital calls, default, restricted liquidity, risks, clawback, transfer restrictions, fees and expenses). It is doubtful that the PRIIPS KIID be sufficient for this purpose. Also, asset managers and financial intermediaries must understand the specific concerns of these investors and differentiate between their various profiles to ensure suitability and appropriateness of the products sold to the investors’ needs. Most intermediaries are already used to this exercise under the MiFID framework which has been designed to ensure investors’ protection by requiring financial intermediaries to assess whether a given investment product is suitable for a given client.
Private market democratisation revolution is underway.
Digital revolution to democracy: Emerging asset digitalization solutions should help to streamline and simplify transactions and reduce investors’ costs. The tool is there but the regulatory framework shall still be adapted to allow distribution via such means to non-professional investors.
Private market democratisation revolution is underway. There is a clear momentum for both policymakers and industry players to achieve a balanced framework permitting retail investors to access private markets while safeguarding their interests. Luxembourg is best positioned to become the preferred jurisdiction for such initiatives, thanks in part to its long-established experience with retail products, its undisputed fund expertise and its innovation capabilities.