SEC director calls for greater retail investor access to private markets

A senior director of the United States Securities and Exchange Commission (SEC) has called for main street, or retail, investors to be given greater access to private market asset classes, to enhance the return profile of their pension portfolios.

Dalia Blass, a Director of the SEC’s Division of Investment Management, discussed the importance of looking at how more retail-type investors can safely access private market asset classes, including through funds managed by hedge fund managers, to level the playing-field in terms of opportunity.

The U.S. SEC’s mission is to protect investors, so moves on private market access are unlikely to be taken lightly.

But this is now the latest discussion among regulators that could result in more capital from less sophisticated investors finding its way into asset classes such as insurance-linked securities (ILS) and reinsurance linked assets, hence of interest to us and our readers.

Blass explained in a speech last week that while access to private market investment asset classes is not entirely new for main street or retail pension savers, it is rare within the now much more prevalent defined contribution pension world.

Defined benefit pension funds have forever tapped into private market asset classes to take advantage of all the features and benefits that an asset class, such as ILS or reinsurance, can provide.

“Private investments have the potential to provide stronger returns and diversification for investors, but come with both performance and liquidity risks,” Blass explained, highlighting the advantages and disadvantages to adding private market assets to main stream investor pension portfolios.

As well as the ability to add an element of diversification and decorrelation, the addition of private market assets can help to improve the overall portfolio return across the investment cycle, given these assets often behave differently to more mainstream equities and bonds.

Defined benefit pension plans seek to make use of the “potentially advantageous returns while seeking to manage those risks,” Blass said, but she noted that the pension landscape is increasingly made up of defined contribution plans which tend to access private markets much less.

“Defined contribution plans have not, historically, provided access to private investments. As a result, Main Street investors are increasingly on the outside looking in,” Blass said.

There are, of course, numerous issues around private market investments and sophisticated alternative asset classes that make them more challenging for main street investors, not least the ability to access them.

But the fact most private investments are structured to the benefit of investors with longer-term horizons, often have higher or more complex fee structures, may offer little in the way of regular liquidity opportunities, be subject to more complex disclosure, regulation, oversight and controls, while the underlying assets themselves may be much more sophisticated and challenging to understand or value.

Despite this, the SEC would like to make access to private market investments and asset classes more readily available, to level the playing field in terms of what U.S. pension savers can have their capital allocated to.

Blass further commented, “I believe there are two potential 1940 Act-registered fund structures we could explore to provide enhanced access to private investments. They are target date funds and closed-end funds of private funds. Both could provide convenient, professionally managed means for Main Street investors to invest in these markets.”

She further explained how these could be suitable fund structures for retail type investors to access private market investments through.

“Registered target date funds are open-end funds. Their portfolios are designed to meet investors’ longer term financial goals and could offer one expedient means for Main Street investors to obtain exposure to private investments. Target date funds could, for example, invest in private markets as a way to diversify risk and potentially enhance portfolio returns. At the same time, private investments would be capped to 15% of the fund’s portfolio.

“Closed-end funds can provide another and different pathway. They do not offer daily redemptions and, therefore, can have more substantial holdings in longer-term, illiquid private investments without having to manage the same risks to liquidity and daily valuation. While a few closed-end funds of private funds exist in today’s marketplace, the staff of the Division has historically raised investor protection concerns if these products were to be offered to retail investors. For this reason, closed-end funds with more than 15% of their assets in private funds have, in the past and at the Division’s urging, limited their offerings to accredited investors,” Blass said.

The SEC’s Division of Investment Management is now actively looking at whether this staff position should be reviewed, “consistent with our firm commitment to investor protection,” and are seeking feedback from fund sponsors, investors and other market participants that have ideas for closed-end fund of private funds that would respond to the SEC’s concerns.

Of course, the insurance-linked securities (ILS) market and the world of reinsurance linked investments remains largely institutional in nature and many involved prefer it to remain this way.

Aside from a number of U.S. mutual funds and European UCITS strategies that allow high-net worth individual investments, ILS remains an asset class for sophisticated investors at this time.

But as regulators like the SEC look to open up access to private market asset classes for pension saves in the U.S., it seems likely the end-result will be that access to alternative classes of investments, like ILS, could become a little easier in time, potentially opening up access to new sources of capital for the dedicated and specialist ILS fund managers in the space.

Concerns over control of allocations and ensuring investors understand what they are allocating to will, of course, be key. Hence it’s important such discussions occur at the right level and any moves to open up private market investments more broadly are undertaken cautiously.