By Eliot Hodges, CEO, Anduin
Investing in private funds may have felt like an exclusive, invite-only event for a select few, but that’s no longer the case. In 2020, the SEC began amending investor requirements like modernizing the definition of an “accredited investor” to broaden access to the private markets and welcome new knowledgeable individuals, regardless of net worth or income. Many individuals working from home during the pandemic with extra discretionary funds took notice. All of this culminated when processes that had been slowly becoming digital, like investing in the public markets or cashing a check via a photo with your bank, got the push they needed to go all the way thanks to lockdowns. Suddenly, investing has become easier than ever.
As the years have gone on, many smart investors realize the need for diversification in their portfolios and may not be satisfied with returns in the public markets. Over the past 15 years, private equity delivered annualized returns of 14%, far ahead of the 9.3% of the S&P 500. Moreover, private markets have less volatility than the public stock markets; a definite positive for all investors.
At the same time, smart GPs who keep an eye on the future see these newer investors as an opportunity to diversify their funds’ LP base. But the private markets can be unfamiliar territory for newer investors who are used to the easy, fast, and efficient process of public market investing. Why should investing in a private fund be so cumbersome and manual when you can get a mortgage, buy a car, or invest in stocks with just a few clicks online?
The need for new digital platforms in the private markets
Many aspects of finance related to public market trading, tax filing, and money management have gone through their own digital transformations. The private markets have lagged in this respect. Private market firms should make it as easy as possible for new investors to not only onboard, but also learn more and access information about their funds and managers.
The challenges of onboarding the next wave of investors
The democratization of private investment has begun, but small investors are still only 2% to 10% allocated in private investments. Why not more? There are roadblocks private funds face when engaging with new investors: their reliance on manual methods for performing due diligence, receiving funds, sending communications, and conducting back-office processes. This manual work often combined with a lack of infrastructure leads to their inability to scale to smaller investors.
Due diligence has a long history of shipping PDF forms back and forth, creating both a duplication of information and effort. When it comes to communications, professionals at private funds are entirely capable of engaging with dozens of institutional investors. Scale that to servicing and answering questions for hundreds of small and possibly less-knowledgeable investors, and it instantly becomes overwhelming.
If back-office operations are not automated, adding new investors to the mix means a greater volume of manual processes, like handling payments. Manual methods don’t scale well and reduce accuracy; the possibility of falling behind or creating errors is unavoidable. This also means collaborating with law firms and fund admins is also all done manually or through any disparate systems they may use, which may lead to increased associated costs as well.
Lastly, the underpinning for fund operations is infrastructure, which is ripe for modernization. Inefficient, slow processes are unattractive to new investors interested in private market funds but accustomed to digitized “click and play” stock brokerage sign-ups. With the right technology, you can ensure investors’ information is submitted accurately from the beginning, saving both time and resources compared to current manual processes.
The consumerization of private market investing
We have all become accustomed to low-friction, self-service, and fast digital transactions in our financial dealings. Private market firms need to figure out how they can consumerize their investing experiences to fulfill the expectations of new investors. By doing so, they will also be able to better battle the challenges they face.
GPs can take a page from consumer-facing TurboTax-like applications which guide users along a happy workflow path. This step-by-step approach simplifies workflow and assists in filling out documents. It serves well for due diligence by cutting friction, reducing dropout rates and increasing accuracy, with typical modern features like autofill that draws on past data entry.
Next, once a new LP has been onboarded for a fund, private firms should over-communicate. Retail investors have become accustomed to a certain level of communication from the public markets. Data-rich and dashboard-heavy environments provided by stock brokerages, such as Fidelity and Schwab, along with real-time stock prices, are what they have come to expect. But a similar constant data flow is not currently common in the private markets. Modern infrastructure enables far more frequent engagement so private market firms can become a trusted partner for new investors, gain their loyalty, and enhance their overall experience.
The bottom line is that private funds need to meet the new generation of investors where they are. These are savvy, high net worth individuals geared to self-service transactions on their personal devices. In any case, the private markets would benefit greatly from bringing all transactions online.
Making private market investing easy
It’s a challenging, yet exciting time. Based on historical performance, private investments will be a boon to this new wave of investors. In the years ahead, private funds—especially the majority that have not yet established their customer experience—will learn how to engage with this growing market and meet its expectations.
To scale up their onboarding, communication, and back-office capabilities, funds can deploy new integrated best-in-breed applications and infrastructure as plug-in solutions. These solutions will not only enhance the investor experience, but compliance, security, and data integrity as well.
Buying or renting proven, industry-leading solutions are the fastest and most advantageous way to get started. Why focus your resources on building an enterprise-grade fintech platform, when you could focus on providing the best investor experience for your LPs instead? The alternative market industry at large can look forward to a brighter future thanks to this technology. Help welcome this new generation of investors and have no problem meeting, and maybe even exceeding, their great expectations.