Until recently, Regulation D of the Securities Act of 1933 limited asset managers’ ability to market alternative products to individual investors, many of which lacked awareness of the investment options in this space. With the JOBS Act lifting the ban on general solicitation and advertising, more individual investors are becoming aware of alternative investment products, often as a result of solicitation by online platforms, and they want access to these offerings.
Why the focus on individual investors? Defined benefit pension plans and other collective retirement pools have for years represented a significant portion of private equity real estate investment activity. DB plans, however, no longer constitute a majority of retirement assets in the United States.
In 1985, DB plans constituted 69 percent of all US retirement assets. Today, however, nearly 56 percent of retirement assets – approximately $14 trillion – are concentrated within individual retirement accounts and defined contribution plans, according to estimates from Investment Company Institute. The ability to efficiently access this growing pool of capital has the potential to transform the fundraising landscape for alternative investments.
Although some investment managers have developed or are developing real estate-related products for the DC market, to date it has been a challenge to aggregate large sums of individual investor capital. Investment managers frequently cite the fragmentation of the individual investor market as a significant barrier to entry, as achieving economies of scale is difficult. Several firms, however, have successfully positioned themselves as intermediaries for the individual investor community, creating more centralized marketplaces to capture this investor demand.
For example, PENSCO, an alternative asset custodian, has developed a specialized niche within self-directed Individual Retirement Accounts (IRAs), which allow more flexibility for owning alternative assets. PENSCO currently has over $10 billion under custody on behalf of more than 45,000 IRA clients. Approximately half of PENSCO’s custodied assets are real estate-related. PENSCO recently conducted a survey of its investors, with 62 percent of respondents indicating that they have either increased their allocations to alternatives or have plans to do so, with real estate remaining a popular asset class among survey respondents.
There have also been efforts to broaden access to alternatives to individuals who bank with smaller Registered Investment Advisors (RIAs). RIAs will readily admit that their clients want more access to alternative products, but local and regional RIAs often do not have the infrastructure or the distribution bandwidth to provide it. These RIAs tend to have around $100 million of AUM across several hundred clients, most of whom cannot meet the minimum ticket sizes to invest in institutional-quality private equity vehicles. Furthermore, forming a conduit vehicle to aggregate smaller orders is an expensive process, and generally not economical for smaller RIAs to do themselves.
This dilemma has created an opening for online platforms to offer illiquid alternative investments through conduit vehicles, which can aggregate smaller ticket sizes into a larger, more institutional-sized order. One such firm is iCapital Network, an online platform focused on providing greater access to blue chip alternative investment products, including private real estate, to the RIA and family office community.
Upon selecting a manager, each RIA or family office user can log in to iCapital’s online portal and download offering documents. For high demand funds, iCapital can form a conduit vehicle to aggregate small orders, often as low as $100,000, from a disparate group of investors into one single subscription for the fund. This approach helps to overcome the two main obstacles that individual investors normally face with alternative products: access and minimum size. In 2015, iCapital processed approximately $300 million of fund commitments for a range of energy, private equity, venture capital, and hedge funds.
The alternative investments industry has been dominated by institutional investors for several decades. However, individual investors are becoming more aware of alternative investment options, and a combination of technology and changing regulation are providing additional points of access. Individuals, whether through their self-directed retirement plans, target-dated funds, or personal investment accounts will have increasing opportunities to invest in low-fee alternative vehicles. That is good news for private equity managers that are looking to access this growing pool of capital.