Private market investing has been a constant theme in wealth management over recent years. Are regulations keeping up with this? Given the issues at stake, the industry must work with watchdogs such as the SEC to ensure that a big prize isn't lost, a platform business argues.

(An earlier version of this article appeared last week on Family Wealth Report. We hope readers find this useful because the insights, while drawn from the US market, apply more broadly.)

Regulators should be encouraged to talk with wealth managers, widen investor access to private markets, and capture diversification and yield benefits, Michael Weisz, co-founder of YieldStreet, a platform in the sector, says.

At present, access to these areas is still a game for the richer end of the HNW population, and for large institutions. There have been tweaks, however: On 26 August 2020, the Securities and Exchange Commission adopted amendments to expand the definition of “accredited investor.” The changes allowed individual investors to qualify as accredited investors based on defined measures of professional knowledge, experience or certifications, rather than solely based on net worth or income.  

For many months, this news service has chronicled moves by various firms such as Moonfare (Europe), CAIS (US), iCapital (US), and ADDX (Singapore) to make access to alternative investments more efficient, and ultimately, more “democratic.” Even for HNW investors, ticket sizes have started from $1 million or more, making this more of an ultra-HNW game. But that’s unsustainable, so it is argued, because this means that millions of investors are forced to hold listed equities, conventional bonds and other assets that aren’t delivering the goods. Rising inflation and interest rates raise the stakes further.

Michael Weisz, co-founder of YieldStreet, thinks a constructive dialogue with regulators can clear a path forward.

“The role of the regulator is always to protect the smaller investor. Investor protection has been historically challenging due to lack of transparency, and lack of widespread information. The controls regulators historically had in place in many cases therefore made sense in that context,” he told Family Wealth Report.

“Today, there are much more sophisticated ways to communicate with retail investors, for instance by using technology. While regulators should continue to require the right levels of disclosure and education for the benefit of the retail investor, they should be promoting rather than restricting access to private markets,” Weisz continued.

“Under the current model, due to lack of access, people are at times encouraged to hold `meme stocks’ and other risky public markets investments that they don’t understand. They [retail investors] are also trading against professional investors who have access to more sophisticated information and use it against them. In private markets, and especially with us, they are investing alongside professional managers. We, as an industry, don’t talk about that enough. People are being harmed by not getting access to investment opportunities that have been carefully vetted for them,” he said.

The situation does appear to be changing. In September 2021, an advisory group for the SEC voted to recommend making it easier for less wealthy people to invest in private funds. The SEC’s Asset Management Advisory Committee approved a report recommending that the regulator increase ordinary investors’ access to private equity, private debt and real estate vehicles (Wall Street Journal, 27 September 2021). 

The number of firms in private hands – rather than those listed on the equity market – has been rising since the dotcom era of the late 1990s, meaning that investors need to adjust their exposures to keep up, or they will miss a big chunk of what drives risk-adjusted returns. For example, private market investments – such as private equity and credit – have exploded 30-fold from 2000 to $30.5 trillion as of 2021, and that figure is likely to have risen since. In 2021, ALTSMARK, a US software solution firm for the private capital sector, said that more than a third of registered investment advisors could be put out of business within a decade if they don’t include alternative assets in their clients’ portfolios.

To support mass adoption of private market investing, there are five foundational requirements: Access (to exciting and enticing investment opportunities), Education (so people feel that they are able to make informed decisions and mitigate risk), Model Portfolio (to eliminate choice theory issues and simplify asset allocation), Liquidity (at some reasonable frequency, as long maturities may not work for many), and Trust/Transparency, he continued.

Platforms and membership
YieldStreet is a platform that enables investors to build portfolios in areas such as private markets. It has about 400,000 members and, so far, about $3.5 billion has been invested in this asset class area via the platform. 

Weisz notes that the private market space is still relatively new. The industry must embrace its educational role through shorter, snappier and more succinct copy that avoids jargon. Yieldstreet has a blog, education resources and related content to help. 

The stakes are high. With as much as $70 trillion of wealth due to be transferred to younger generations, there are around 15 million US accredited Investors and about a further 30 million earning $100,000 or more a year – a big market for these areas. The same pressures and dynamics, to varying degrees, operate in Europe and the UK. (The UK's Financial Conduct Authority has brought out plans for a "Long Term Asset Fund", designed to "invest efficiently in long-term, illiquid assets". The UK watchdog is trying to craft a regime through which affluent investors can enter the space, with certain safeguards. The move is likely to be emulated by regulators other major jurisdictions.

Regulatory concerns
Back to the subject of regulation, a concern that watchdogs around the world have had is that private market investing is typically less liquid than holding a fund of stocks or bonds. With open-ended funds, for example, there can be a mismatch between the liquidity expectations of clients and the underlying assets. (In Europe, this can be problematic with real estate funds, as seen with temporary closures of UK property funds that were hit in the summer of 2016 after the Brexit referendum.) Regulators want to avoid nightmare headlines of retail clients trapped in funds which they cannot get out of.

However, scale will help with the liquidity question as more people enter the space, Weisz said. “The community of people investing in private markets should be large enough to be able to support the creation of secondary markets…this doesn’t need to be daily liquidity.”

Under the chairmanship of Gary Gensler, the SEC is considering imposing some of the reporting/disclosure requirements on private equity and hedge funds that apply to listed companies. That might dampen some of the attractions, at least on the margins. The regulator is mulling rules to require more private companies to disclose information related to their finances and operations. Companies that are privately held often circumnavigate current reporting rules, which are based on the number of investors. Gensler and the SEC reportedly want to close those loopholes. In January 2022 the SEC proposed a series of rule changes that call for more information disclosures, faster, from a larger pool of private equity and hedge funds. For both classes of investors, the rules would require next-day disclosures of significant events.

Whatever certain bumps in the road there are, YieldStreet’s Weisz is convinced that widening access ought to be a priority, and his firm is determined to be a part of that process. 

In a high inflation environment, with all the issues around volatility, rising rates and fears of recession, Russia/Ukraine/supply-chain disruptions and shortages…”inaction is more tempting than taking action. We really have to think about where we should be comfortable investing,” he said. 

Weisz likes areas such as single-family rentals and multi-family rentals. “The best hedge against inflation has always been real estate. Owning the actual asset has always been a good inflation hedge.”