Why Some RIAs Might Fear Private Equity Investments

Registered investment advisors (RIAs) have historically been wary of suggesting alternative investments to clients, especially private equity. There are a number of reasons this happens. Large private equity funds are not easy to access, nor is private equity always easy to understand. 

But things are changing. Mounting evidence indicates that traditional portfolio management strategies are failing in an environment with high inflation, rising interest rates, and economic uncertainty. It is perhaps unsurprising then that allocations to private equity firms were up 500% year-over-year as of mid-2022. This trend will likely continue in 2023, as a recent survey found that 70% of investors polled believe private equity will generate the best returns this year.

But despite demand, the 2022 Fidelity RIA Benchmarking Study found that these advisory firms only allocate 6% of assets under management to illiquid alternative investments, with only a portion of those assets allocated to private equity. What’s the hold up? Let’s break it down.  

RIA Investment Buying Power Limitations

Obtaining the minimum investment required by most private equity fund managers is a major obstacle. Lawrence Calcano, chairman and CEO of iCapital Network, argues that the commitment levels required by fund managers can discourage potential investors.

“The minimum commitment levels required by fund managers from investors typically ranges from $5 million to $20 million, which makes many funds out of reach for all but the biggest investors. This reflects the fact that private equity has traditionally been the domain of large institutional investors, such as pension funds, endowments, and foundations,” Calcano said. 

It is worth noting that the significance of these high minimum investments depends on the RIA. Larger players with high average account sizes have an easier time meeting those minimums on their clients’ behalf. This is reflected in the previously referenced TD Ameritrade report, where firms with more than $1 billion in assets under management were almost three times as likely to make allocations to illiquid alternative investments like private equity than smaller RIAs. 

Substantial Due Diligence Requirements

Private equity investments require a great deal of due diligence to evaluate fund managers and potential deals. The process can be time-consuming and arduous. Many RIAs lack the resources to complete such due diligence on multiple, individual private equity funds for multiple, individual investors. 

This is another area where things are shifting, though. Recent years have seen an uptick in due diligence outsourcing to third-party service providers, decreasing the research and analysis burden for RIAs.

Lack of Private Equity Understanding

It’s not easy to explain private equity to clients, and many RIAs still need more education themselves. Although private equity funds have significantly outperformed the S&P 500 over the last decade, some RIAs still lack understanding of their potential risks and rewards.

“Alternatives as an asset class is a relatively new option for investors and advisors,” explained Calcano. “Advisers still need to educate themselves and climb the learning curve on these products to get a better understanding of the timelines, the fee and compensation structures, and the overall investor experience before discussing these investments with clients.”

Seeking further education could empower RIAs to more comfortably suggest private equity opportunities to their clients. Fortunately, with a plethora of resources available online, that education is easier to attain than ever.

The Nature of Private Equity

RIAs may struggle to pitch investors on private equity allocations because of the way they operate. These are investments are long-term, highly-illiquid investments. This sometimes makes them unappealing to clients or advisors. 

Investors must also pay fees to fund managers. The prospect of paying those fees and their impact on overall portfolio performance can be off-putting in some cases. Paired with the fact that fund managers do not always provide timely or adequate reporting, some investors may be skittish about their ability to evaluate investment success. 

New Opportunities on the Horizon

Despite the hesitation to include alternative investments in their clients’ portfolios, RIAs may have an easier time accessing and evaluating private equity deals thanks to several companies. 

In late 2019, for instance, Schwab Advisor Services created a new platform to provide alternative investment opportunities to RIAs through third-party sponsors. The platform eliminates custodial fees, and its first sponsor was none other than iCapital Network, which provides research and performs due diligence for RIAs. 

Other platforms like CAIS and companies like PPB Capital Partners and Republic Capital Group also provide support for evaluating private equity investments. 

It will take some time for RIAs to catch onto private equity as the SEC and the JOBS Act continue to open up the space for more and more investors. But catch up they must. Private equity can be an important tool for portfolio diversification with higher return potential. 

The bottom line? One way or another, RIAs need to figure out how to meet the burgeoning investor demand for private equity options if they truly want to help their investors reach their financial goals.  

If you’re interested in hearing more about private equity, our Due Diligence Before Investing webinar is an excellent place to start. Want to learn more about other distinctive investments? You may find the following webinars interesting:

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For more information about our on-demand webinar series, click here.

This is an updated version of an article originally published on July 13, 2016. ©2023. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.