How Retail Investors Can Invest in Private Equity Funds
If anyone is wondering why Elon Musk has such a fan club, it’s because his inner nerd harkens to those who appreciate immature geniuses. Look no further than his recent announcement that he might start a university in Texas – the Texas Institute of Technology and Science. For most people commenting on this tweet, it went entirely over their heads.
After announcing his possible foray into the education sector, the Internet was abuzz with banter. Who will fund it? What topics will they teach? Mr. Musk addressed suggestions that the word “science” should come first – Texas Institute of Science and Technology. “Nope, T is definitely first,” Mr. Musk said, as he talked about the epic merch that would no doubt be on display at TITS University. “Universally admired,” said Mr. Musk, and he’s certainly right about that.
Two takeaways from that. First, it’s always important to never take yourself too seriously, even if you’re the richest man in the world with a net worth of over $300 billion. Second, always pay attention to details. Many don’t, and it’s why investment advisors make loads of money. One of those companies is Franklin Templeton (BEN), one of 30 stocks we’re invested in as part of our dividend growth investing strategy.
Templeton’s Alternative Assets
One of the strongest performing stocks in our dividend growth portfolio has been Franklin Templeton, a company we were concerned about before because it didn’t seem like they had much of a direction. That’s not the case anymore, as investors have been rewarding the company for their recent decision to acquire a large private equity firm to further their move into alternative assets. Before we get into that, let’s talk about how Franklin Templeton makes money.
We all understand how fees work on a fund or ETF. The expense ratio is a fixed yearly cost the manager gets paid regardless of how well the asset performs. Franklin Templeton has about $1.53 trillion in assets under management (AUM). (To put that number in perspective, the world’s largest asset manager – Blackrock – has about $9 trillion in AUM.) With 2021 revenues of $8.43 billion, Franklin is charging about 55 basis points (0.55%) on their AUM, a number that sounds about right.
Increasing AUM increases revenues, but not all AUM is equal. Here’s a breakdown of what asset classes Franklin dabbles in.
That “alternatives” chunk you see above just increased to $200 billion because Franklin bought a private equity firm called Lexington Partners. Here’s how that fits into the other alternative assets they’re holding.
Over time, the amount of money Franklin puts into alternatives is growing.
And here’s why.
The broader market trend is for asset managers to think outside of traditional asset classes – stocks and bonds – and diversify into other areas such as alternatives like private equity (PE). This got us thinking about our own asset allocation strategy.
Our Asset Allocation Strategy
This whole thing came up when looking at how we’ve allocated our own assets under management. Around 8% is dedicated to alternative assets – gold, wine, art, and bitcoin.
The yellow bars seen above qualify as alternative asset classes, but perhaps not the most prudent ones to own. At the top of the list would be real estate, hedge funds, and private equity. But let’s just be honest here. You’re going to get a lot more tail by casually mentioning that Louis Roederer Cristal 2000 you just bought, or the Yayoi Kusama piece you invested in, rather than talking about your investment in a Lexington Partners secondary private equity fund.
At least when it comes to private equity, the problem kind of sorts itself out. Right now, we don’t believe there’s a viable way to invest in a top-ten private equity fund. If you’re getting ready to email us about firms like Moonfare, or others of their ilk, put down that digital pen and hear us out first.
How to Invest in Private Equity Funds
To make this conversation simpler, let’s keep venture capital out of this conversation. Yes, it’s a form of private equity, but the type we’re talking about here would be funds managed by the top private equity firms in the world, names like Blackstone, Carlyle, and KKR.
Private equity funds have historically been exclusive to institutional investors like sovereign wealth funds or pension funds. Aside from maybe ultra-high net worth individuals, it’s highly unlikely large PE firms would want to work with individual investors who have a whopping 50K they want to put to work. Lately, there’s been a lot of talk around opening up private equity investing to retail investors. Zee Germans are making that happen for Asian and European private investors with a firm called Moonfare.
Private Equity Gateway Platforms
First off, kudos to the Moonfare marketing team. You’re putting together incredibly good content to guide investors. And you darn well should be, considering how much you’re charging them. From an article by Wealth Manager which talks about platforms like Moonfare:
It is important to note that the platforms charge fees on top of what investors would pay for the underlying funds – which is typically around a 2% management charge and 20% performance fee.Credit: Wealth Manager
Moonfare’s value-add here is simply access to large private equity funds – all of which charge their own fees – along with offering some liquidity. We’re not investing money we need anytime soon, so liquidity isn’t an issue for us. What is an issue are those massive fees. Why the heck does this firm get rewarded if some other firm is responsible for performance? Charging more than 50 basis points for access to a fund isn’t anything we’re interested in.
Private Equity Stocks
There are some publicly traded private equity companies like Brookfield Asset Management (BAM) and Blackstone (BX) which each have a market cap exceeding $90 billion. But investing in companies that create private equity funds and manage them isn’t the same as investing in the funds themselves. You won’t enjoy the same diversification effect you would get from investing in the actual funds, and you’re not guaranteed to enjoy the same performance as the underlying funds. (We’ve discussed this before in the context of publicly traded venture capital firms.)
Blockchain and Securitization
In our recent piece on Securitize, we talked about the massive opportunity to be had in unlocking private equity by giving it liquidity. Securitization could potentially provide a low-cost avenue for investors of all types to buy into private equity funds. We don’t know much about what plans Securitize might have, but this is likely a direction they’ll take. What they’ll charge if they do make this happen remains to be seen.
There are also quite a few other firms looking at using blockchain to create new assets for retail investors. A recent piece by Blockdata compared nine different asset tokenization platforms, some of which are surely looking at making private equity more accessible.
Other Ways to Invest in Private Equity Funds
If there are other avenues out there for investing in top private equity funds which we didn’t talk about today, we’d love to hear about them. We say “top private equity funds” for a reason because those are the fund managers we want to entrust our money with. So, whoever provides us with access to a top fund should charge a reasonable fee for the privilege. None of this 2 and 20 stuff. Half a percentage point seems like a fair price considering they’ll probably need to front the money to invest in the fund first, then divvy up access to retail investors.
Nothing fancy will come at that price and we’re okay with that. We don’t expect to have liquidity because that’s just added costs, nor do we expect there to be much selection. A couple funds from several of the top-ten private equity firms out there will do just fine. Since we expect you’ll be using the term “blockchain” to raise the money for your venture, we’ll assume you’ve properly securitized the whole thing, and minimums can start at $10,000 so that us commoners can dip our toes in the water. If that sounds like you, please drop us a note as we have plenty of investors – both accredited and non-accredited – that would be interested.
Update 11/08/2021 – A reader alerted us to a firm called Aqua, an investment platform that allows individuals to invest in private equity at lower minimums. We’ll look to cover them once their platform starts offering investment products.
It’s important to take a holistic look at your own asset class allocation picture. Ideally, you’ll want to have a chunk of your money in alternative investments like commercial real estate, hedge funds, or venture capital funds. Private equity may be off limits for now, but it’s an asset class to keep an eye on. A well-diversified portfolio of assets will help you sleep well at night, and always give you something to be excited about, even in times of economic turmoil.
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