President Trump recently signed an executive order making it easier for Americans to invest their retirement savings in private companies. The move fulfills a long-time goal of Wall Street firms to tap into the $9 trillion pool of money held in 401(k) plans. Is the democratization of private markets a positive for individual investors?

It remains to be seen whether the order on retirement plans will encourage employers to offer private investment funds in 401(k)s, which tend to be less liquid and charge higher fees. Firms that invest in private markets say those fees are justified by the potential for higher returns, but the risk of litigation may slow employers from making the move.

Whether 401(k)s start offering private funds or not won’t stop private equity firms from increasingly turning to individual investors for growth. Institutional investors, such as large endowments like Harvard and Yale, have reached their “full allocation” to private investments. Additionally, many large universities facing federal funding cuts need access to liquidity and have become sellers of their private investments. This leaves little room for further capital deployment from this traditional client base.

Simultaneously, the private wealth market, consisting of individual investors, presents a massive, untapped opportunity. According to data from Bain & Company, the global private wealth market is roughly $145 trillion, yet its allocation to private markets is a small 1-3%. The opportunity to charge higher fees in private markets compared to fee-compressed traditional asset management creates a powerful incentive for firms to attract private wealth. Cynically, the move to “democratize” private equity is a self-serving effort by private equity firms to find a new source of capital.

Companies staying private longer

There are a few compelling reasons to invest in private companies. The rise of private markets has been one of the most significant developments in capital markets in recent years as private companies are taking longer to go public. Regulatory changes, intensified reporting requirements, higher litigation expenses, heightened public scrutiny and the relentless pressure of quarterly earnings are driving companies away from public markets. The number of publicly traded companies in the U.S. is shrinking. At the peak in 1996, there were 8,090 publicly traded companies in the US, compared to approximately 4,000 companies today. Furthermore, 81% of US companies with more than $100 million in revenue are privately held.

Private Investments for a New Audience

A key barrier to entry for individual investors has been the structure of traditional private equity funds. These “closed-end draw-down vehicles” require a long-term commitment of capital, often spanning 10 years, with no ability to redeem investments during that time. This illiquidity is a significant hurdle for retail investors who might need access to their capital.

To solve this, the industry has developed new structures, most notably evergreen funds and interval funds. These funds are different because they allow for continuous investment and offer limited redemption rights. While they are not fully liquid, they provide scheduled windows, typically quarterly, where investors can request to withdraw a portion of their capital.

This product innovation addresses a significant criticism of private markets which is the perceived lack of transparency and liquidity. Private markets appear less volatile because their valuations are marked quarterly rather than daily. This can be misleading, as a private portfolio might not immediately reflect a public market downturn. Additionally, publicly listed companies are subject to regulatory oversight and disclosure requirements, which help ensure transparency and maintain investor confidence.

Conclusion

Investing in private company funds can be complex, involving higher fees and risks not typically found in publicly traded companies. As financial advisors, we’ve noticed an increasing trend of emails promoting private funds, and we don’t expect this to slow down. While we will continue to evaluate all investment options for our clients’ portfolios, this trend presents an interesting opportunity: investing directly in the publicly traded companies that manage these private funds. These firms (such as Blackstone, Apollo, and KKR) are likely to benefit from the growing capital flows into their funds. Once money is in their funds, it becomes “sticky,” allowing them to charge high fees. This makes for a profitable business model and an interesting investment opportunity.

The opinions expressed in this post are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual. It is only intended to provide education about the financial industry. Individual investment positions discussed should not be construed as a recommendation to purchase or sell the security. Past performance is not necessarily a guide to future performance. Please remember that investing involves risk of loss of principal and capital. Nelson Capital Management, LLC is a registered investment adviser with the U.S. Securities and Exchange Commission. No advice may be rendered by Nelson Capital Management, LLC unless a client service agreement is in place. Likes and dislikes are not considered an endorsement for our firm.