The SEC recently tweaked "Accredited Investor" rules. The hope among some wealth managers might be that this eases access to areas such as hedge funds, private equity and infrastructure. The change is not, however, as dramatic as might appear and private clients face continued hurdles, an RIA says.
The US recently changed rules governing how private investors can hold alternative assets such as private equity, but don’t expect a rush into the space, a wealth management firm says.
The Securities and Exchange Commission adopted amendments to the Accredited Investor rules. (See here for a detailed breakdown.) People can qualify as accredited investors based on professional certifications, designations or other credentials from an educational body. Historically, individual investors who do not meet specific income or net worth tests, regardless of their financial sophistication, have been barred from this sector.
“A move to give broader access to private or exempt securities is a step forward,” Eric Knauss, founder of Proteus, a Registered Investment Advisor, told this news service. Knauss has worked in the investment sector for 37 years, working at Merrill Lynch, T Rowe Price, Genspring, and Lazard. Then he moved to Archway, the business bought by SEI. Proteus, an RIA based in Indiana, was spun out of Archway in 2017.
While the SEC has taken a positive step, Knauss does not think that the change will have a dramatic impact in widening the pool of investors able to tap into alternative assets such as private equity and hedge funds. He argues that this is down to a number of reasons.
“There are two major sets of exemptions that funds can use to avoid registration under the Investment Company Act of 1940. One set requires investors in the fund be accredited investors (net worth of $1 million or greater) and it allows up to 100 investors to participate. The other set requires investors be qualified purchasers ($5 million in net worth or greater) and it allows up to 2,000 investors to participate,” he explained.
“Managers that are newer or less established typically opt to structure their fund utilizing the first set of exemptions since they can then make their fund available to the largest pool of potential investors (accredited) but are limited to a maximum of 100 investors they can accept into the fund,” Knauss continued.
“Managers that are more established, are well known, have a strong track record of performance or have an institutional client base almost always opt for the second set of exemptions since they allow for a greater number of larger investors to participate. The result is that most of the more established, institutional quality managers are not available to accredited investors,” he said.
Another point, Knauss said, is that if a fund is created using the first set of exemptions and charges a performance-based fee, as most traditional alternative managers do, then to be eligible, the accredited investor must also be a qualified client which generally requires a $2.1 million net worth instead of the $1 million threshold.
“Given these circumstances it is difficult and sometime impossible for accredited investors to access top tier private equity funds. As such, changes to the definition of accredited investor have little to no impact on who can access the top tier funds,” Knauss said.
HNW private investors have an access problem and this has perplexed the investment industry for years. The sector has tried entry points such as liquid alternatives, interval funds, UCITs, Business Development Corps (BDCs), Special Purpose Acquisition Companies (SPACs), non-traded REITs, structured products and more. Some of these structures have drawbacks. For example, the underlying assets in UCITS funds must be liquid enough to match the daily dealing that end-clients sign up for. (One of the biggest questions for “liquid alternative” funds is whether the promises of liquidity stand up in practice.)
It’s no surprise that a wider circle of investors want to get past the “velvet rope” and into the alternative assets party. The potentially superior yields that private capital – debt, equity, real estate and infrastructure – can deliver compared with listed markets, is attractive to investors at a time of near-zero or even negative official interest rates. That higher yield comes with low liquidity – a trade-off that has concerned regulators, particularly at times of market stress.
There is a lot at stake. The volume of private capital runs into billions. To cite private debt, for example, a total of $34 billion of private debt funds were raised among 49 funds in the second quarter of this year. Within private equity, $116 billion was raised in the quarter (source: Preqin). For the most part, only institutions, including family offices, and ultra-wealthy individuals deemed “accredited”, could participate. In recent years a number of firms, such as the New York-based financial platform iCapital Network, have expanded offerings, saying that they democratize access to such non-public investment asset classes.
Into the game
Proteus reckons that it has figured out a way to get private investors ringside seats.
“We are a technology company and we think we have solved a financial problem not a financial company trying to build technology,” Knauss said. “We have the ability for accredited investors to access top tier private funds. We aggregate assets through the platform so that investors can get access below the stated minimums.”
“We simplify the process. We automate the subscription [to securities] process on the front end. We also provide full back- and mid-office support,” he said.
Proteus is already in action; its structures for enabling investors to enter these assets have already been put to work, Knauss said.