STATESIDE: Drivers of innovation

The ‘olden days’ is a relative term and depends largely on context. For Oaktree Capital Management’s John Frank, the olden days of raising capital from retail investors were just a few years ago.
Back then, funds were being distributed through the private wealth divisions of wire houses. Investment banks such as Morgan Stanley or UBS would create a feeder fund to pool numerous high-net-worth clients and make an aggregate commitment, typically between $25 million to $50 million, to a fund. The manager itself didn’t pay for distribution.
In the wake of the global financial crisis and regulatory changes resulting from the Dodd-Frank Act, however, the wire houses now charge for distribution to their private wealth clients. “Mostly, we raise as much capital for our funds as we want, so there’s no real reason for us to pay for distribution,” Frank told PERE.
The fact that Oaktree nonetheless is paying for distribution speaks volumes about the growing clout of high-net-worth investors. In real estate, the firm distributed its most recent fund, Oaktree Real Estate Opportunities Fund (ROF) VI, through Barclay’s high-net-worth business. “That’s something that we’re experimenting with more than we did in the past,” he said. 
High-net-worth investors, which generally are considered individuals with a net worth of between $1 million and 
$5 million, have become a growing source of capital for general partners in recent years. In fact, many of the top private equity real estate firms have raised significant amounts of capital from the retail channel with their most recent property funds. Those vehicles, however, nonetheless were geared toward larger institutional investors that could write checks of several hundred million dollars. What’s notable now is that some sponsors have been making a targeted and focused push to tap into the retail channel and are seeking to create products specifically tailored to such investors.
Oaktree, for example, currently is focused on creating new vehicles and structures that would help to increase the firm’s number of retail investors, which currently comprise approximately 13 percent of its client base, primarily through its sub-advisory relationships with various mutual fund managers. It also has hired additional staff to support these efforts and expects to continue to distribute new products, which could include the successor fund to ROF VI, through the wire houses.
“Even though we have no trouble raising money, you can’t have enough legs to the stool,” said Frank, who views the more targeted outreach to retail investors as a longer-term, five- to 10-year initiative. “We may have certain products where we create something that’s ideally packaged for that channel, and we have all the bells and whistles that channel likes as opposed to what an institutional investor likes.”
Meanwhile, private equity firm Kohlberg Kravis Roberts (KKR) reportedly is planning to set up a private trading market with Nasdaq to allow its investors to sell parts of their stakes in buyout funds. Pension plans and other large investors would be able to sell pieces of fund interests to smaller investors for as little as tens of thousands of dollars, significantly lower than the millions typically needed to acquire a stake in a buyout fund. While the initiative is focused on the firm’s buyout funds, there’s no reason that the market could not eventually be expanded to allow the trade of stakes in other types of KKR funds, including real estate.
“What you’ve seen are GPs trying to get more creative around what products they’re bringing out to the retail community,” said Robert Klein, head of alternative investments at JPMorgan’s private wealth division. GPs have been examining multiple types of public and private vehicles, including real estate debt funds and mortgage REITs, to meet the myriad and changing needs of retail investors.
Klein noted that JPMorgan’s private wealth clients have not only been investing more in private real estate, but they have diversified their investment strategies to include both equity and debt, as well as multiple geographic regions. “It’s across the board, whereas five years ago it was more plain vanilla, US equity real estate,” he said. “There are many more flavors that our clients are choosing from today.”
Still, the retail client base can be difficult to access, as it is a somewhat fragmented market, with providers ranging from retail brokerage houses to global private banks to consultants. Another challenge for fund managers looking to launch retail products is addressing concerns about investing in illiquid asset classes such as real estate. Retail investors, after all, need to consider the tradeoffs between liquid and illiquid vehicles and should expect a higher annual return premium to compensate for illiquidity, Klein explained.
So, although high-net-worth investors may present a growth opportunity for many private equity real estate firms, navigating the retail channel isn’t easy. That said, the effort isn’t only worthwhile but necessary if managers want to stay at the top of their game. While such investors represent a considerably smaller pool of capital than pension plans or sovereign wealth funds, one would be foolish to consider the retail channel in terms of dollars alone. After all, high-net-worth investors now are driving general partners to think more outside the box than ever before. And innovation is anything but business as usual.