The Retail Market is More Than You Think It Is

Ask a CIO: Week 6

The Fourth of July is one of my favorite holidays – a celebration with family and friends, picnics and barbecues, fireworks and parades. We’re publishing a day early to wish you all a happy 4th!

We’re also taking a break this week from reader submitted questions to reflect on some of the questions that we asked ourselves as we were starting Ivy Invest¹. The retail investing landscape is dynamic and growing. Whether you’re an individual investor or a GP considering retail investors, I hope you’ll find this week’s newsletter informative.

And if not, then you can look forward to our next newsletter, coming out on July 18^th, which will feature a 30+ year veteran CIO guest answering questions. I’ll be out of office next week, so you’ll have two weeks to get your questions in for our guest CIO: askacio@ivyinvest.co!

Level-setting

We started this endeavor with an open mind. We wanted to know: how big is the gap between institutional and retail investors? What are the current alternatives options available to retail investors? How do we know if retail investors care about investing in more than stocks and bonds?

By now you’ve probably seen the charts comparing the portfolios for institutional investors to those of retail investors. For those who haven’t, one estimate from Fidelity shows that retail investors with financial advisors allocate 6% of total assets to alternatives, as compared to 23% for the average institutional investor (and over 30% for endowments & foundations)². I would confidently guess that investors without financial advisors are well below 6% allocated to alternatives, for reasons we’ll explore in our final question this week.

Unsurprisingly, the differences in retail versus institutional allocations have consequences.  For instance, public markets account for an increasingly narrow slice of the American economy – fewer than 15% of companies with over $100 million in revenues are publicly traded³. Limiting a portfolio to listed stocks limits exposure to the broader American economy, particularly the fast-growing technology companies that are overrepresented in private markets funds vs. public markets indices. On a go forward basis, as I wrote about previously, the return expectations (capital market assumptions) for private equity and private credit exceed those of traditional stocks and bonds⁴. Excluding private assets therefore likely means lower expected returns.

We believe the gap needs to be addressed, and we’re certainly not the only ones. The alternative investment options available to retail investors started out in a limited and fragmented way, with early fintech platforms offering niche exposure to art or private loans. In the past few years, however, new retail investments are increasingly coming from experienced, high quality, institutional asset managers⁵.

It’s a game changer – institutional asset managers are innovating quickly, creating new vehicles for retail investors. Today, it’s not just private feeder funds for ultra high net worth retail investors. Investment managers, where it makes sense, are also replicating their long-standing institutional strategies in unlisted, evergreen closed-end registered funds⁶. In some cases, these evergreen funds make investments pro rata with the manager’s drawdown commitment funds (with some necessary differences to account for the different liquidity profiles)⁷.

We believe the success of retail-oriented strategies as measured by AUM growth is remarkable⁸. We take it as an indication that retail investors are eager for more options, and they want options from credible, experienced investors.

Problem-solving

We see a clear shift toward increasing investment options for retail capital, and we perceive it as an accelerating trend that’s here to stay. Why are firms increasingly choosing to launch unlisted, registered closed-end funds (CEFs)? And why are they being well received by the retail market?

As we learned during our own buildout, CEFs address the most fundamental challenge. These structures solve for two variables: 1) flexibility to invest in non-traditional assets⁹; and 2) ability to take in retail investor capital¹⁰.

Historically, alternative asset managers typically offered their strategies through private funds, most commonly 3(c)(7) funds. These funds provide endless flexibility from an investment standpoint, but no flexibility to accept retail dollars (all investors must be Qualified Purchasers per the fund’s legally mandated regulatory requirements.)

Before we go any further, I’m going share a list of retail investor categories; for the most part, wealth and income determines where an investor sits.

• Qualified Purchaser

  • Investor with over $5 million of investable assets, not including primary home

• Qualified Client

  • Investor with over $2.2 million of investable assets, not including primary home; OR

  • Investor that has a financial advisor, and has at least $1.1 million in assets with that advisor

• Accredited Investor

  • Investor with over $1 million of investable assets, not including primary home; OR

  • Investor with income >$200,000 in each of the past two years; OR

  • Investor with spouse and combined income >$300,000 in each of the past two years

Your eyes may have glazed over, but these specific categories almost exclusively determine what, if any, investment options are available to any individual investor.

CEFs have the flexibility to accept investors below the highest threshold, Qualified Purchaser. Whether any fund chooses to lower the threshold is up to the fund, but this ability – to lower or remove net worth qualifications altogether – is significant. It significantly eases access for retail investors.

Without getting into the weeds on the types of CEFs, asset managers are typically choosing tender offer and interval funds. Our own fund¹¹ is a closed-end fund operating as an interval fund, so we’re intimately familiar with this category.¹²

We spoke with a number of financial advisors and CIOs at RIAs to better understand why these particular CEFs are resonating. The top cited benefits: 1) evergreen investment with immediate exposure, versus private commitments funds that experience J-curves and require capital call management; 2) some liquidity, even if limited: CEFs typically offer quarterly liquidity with a fund-level gate; and 3) easier tax documents: CEFs issue 1099-DIVs vs. private funds that issue K-1s.¹³

The product-market fit of CEFs is still being proven out, but I’d say the early evidence is compelling¹⁴.

Building

Finally, we needed to understand distribution. How do individual investors currently access registered closed-end funds? And what’s the alternative?

The success of any given fund in the retail market depends on its distribution network¹⁵. This wasn’t a particularly surprising finding for us. What was surprising, is that financial advisors – RIAs and wirehouses – are effectively the only distribution channel for unlisted closed-end funds.

Even interval funds, which commonly have daily NAVs and tickers, are difficult to purchase without financial advisors. Those of you with Bloomberg terminals can easily find the tickers for the largest ones out there. You can enter the ticker on your personal Schwab or Fidelity account, and the fund might even pull up. But try to purchase, and you’ll find that you can’t.

This friction is part of our opportunity. A reasonably large subset of investors (some with a lot of investable assets and some with fewer) don’t work with financial advisors for any number of personal reasons. We believe those individuals should also have access to alternative investments from credible, experienced investors.

So we built a proprietary tech platform, Ivy Invest, to deliver our Fund, and by extension other private and closed-end funds, directly to our customers through a modern consumer app experience. It was a major undertaking, and we’ll have more to say about that another time, but we think this is the next step forward.

Thanks to everyone for joining us each week! As I noted at the outset, we won’t publish next week, but we’ll be back with an incredibly knowledgeable guest on July 18^th. So get your questions in: askacio@ivyinvest.co!

Wishing you all a fantastic July 4^th!
Wendy

1. Buena Capital Advisors, LLC d/b/a Ivy Invest

2. Fidelity: A Study of Allocations to Alternative Investments by Institutions and Financial Advisors, 2023

3. Bain Global Private Equity Report, 2023

4. Using a sampling of capital market assumptions from JPMorgan, BlackRock, and PIMCO

5. Blackstone was an early mover on the real estate side and Partners Group an early mover on the private equity side. There are certainly other examples of firms that identified the potential in retail capital 5+ years ago, but the emerging consensus among institutional asset managers is more recent.

6. The degree to which GPs are replicating their institutional strategies versus offering completely new strategies varies by manager and fund, and as always, careful due diligence is necessary.

7. It’s a much longer discussion for another day, but it has me reevaluating upward my own illiquidity premium for drawdown commitment funds.

8. KKR is raising $500 million each month across the firm’s retail funds. Recognizing that KKR is almost certainly an outlier, the sheer size is indicative of broader retail demand. Source: KKR Q4 2023 Earnings Call Transcript and Investment News.

9. In our case, Ivy Invest makes both traditional and non-traditional investments.

10. Unlisted CEFs are not new structures. Interval funds and tender offer funds have existed for decades and have been used with varying levels of success. Some key differences that I would note in the current environment: large asset managers are launching funds for established strategies, and asset/liability matching is a common point of discussion. Private credit strategies with natural liquidity are the most common assets going into new CEF funds, followed by private equity, particularly secondaries strategies. Of course a fully locked up private fund is the optimal asset/liability structure for private assets, but that’s not feasible for retail investors.

11. The Institutional Investment Strategy Fund (“IISF”) is an investment company registered under the Investment Company Act of 1940. IISF is a closed-end fund operating as an interval fund that makes quarterly repurchase offers and as such provides limited liquidity. The fund commenced operations on March 1, 2024. An investor should consider the investment objectives, risks, charges and expenses of an investment. The Prospectus contains this and other information. Read it carefully before investing.

12. While we were going through the SEC registration process, we mapped the interval fund landscape. We spoke with a number of longer-running funds, who generously shared with us their experience and expertise from service provider recommendations to building distribution channels. We’re here to pay it forward.

13. We heard multiple times, in multiple ways, from financial advisors that their retail clients were not willing, and probably would never be willing, to invest in drawdown commitment funds with 10+ year lock-ups.

14. XA Investments publishes great research on the evolving CEF marketplace. Some interesting data points from XAI: as of May 31, 2024, there are 227 tender offer and interval funds with $168 billion in AUM. Less than a year ago, in September 2023, there were 196 tender offer and interval funds with $122 billion in AUM.

15. I think of the CPG sector as a useful comparison. You can have the best CPG product, but distribution determines product success. It’s hard to get shelf space, and how many types of oat milk does any store need to carry?