Back in November, Institutional Investor reported on a joint venture between State Street and Bridgewater, an effort to diversify their product lineups and client bases and tap into retail investors’ growing appetite for alternative strategies — without having to build capabilities from scratch or make a difficult acquisition.
This followed other such tie-ups. In May, KKR and Capital Group announced plans to introduce hybrid public-private market investments this year, and last September, State Street and Apollo launched an exchange-traded fund that has both public and private deals, the first of its kind.
Collaboration between PE and traditional asset management firms to provide more offerings to more investors without years of groundwork is well on the way to becoming a trend. However, differences in expertise, fee structures, and expectations can cause logistical headaches and must be carefully considered if the joint ventures are to prosper, sources note.
One challenging concern with offering private investment to retail is liquidity mismatching. PE by its very nature is illiquid, whereas retail investors want exposure to private markets but often expect to be able to redeem their money at any time.
Garland Allison, co-chair of Cooley’s private equity practice group, says that institutional investors are used to how private markets function and to having their money tied up for a significant period. “We’ve seen over the past several years, [when] there have not been a number of exits like in the past, LPs clamoring for return of capital, but yet they’re still used to being in it,” he explains. “Whereas when you start to bring in these smaller investors, it does create concerns about liquidity. The bigger issue is how you deal with the differing needs of this type of investor.”
Retail investors may dislike the lack of liquidity in private markets, especially during a downturn, but the difficulty of exiting and the distribution drought caused by cost-of-capital and valuation changes will compound the misery.
There are various mechanisms that can bring liquidity, including ETFs, which investors can sell at any time to another buyer on an exchange, without the manager having to touch the underlying portfolio. The ETFs can also be structured to include public fixed income securities, which can be sold more easily than private credit. GP-led secondaries, which can provide some liquidity by selling a promising company from one institutional fund (and distributing the cash to investors) and putting it into a new fund with a new set of investors.
Figuring out how to transform illiquid products into liquid assets is “the holy grail of alts asset management,” says Bob Elliott, CEO and CIO of Unlimited Funds, which he co-founded to offer retail investors access to hedge fund returns through ETFs.
Some of the products on the market that do this are not particularly innovative or interesting, Elliott adds, but those like Apollo’s private credit structure “really open the door for doing this transformation” and are indicative of where the entire industry is going.
Apart from issues with the products, critics highlight structural concerns about the joint ventures themselves.
The justification for them is clear. Private markets firm Hamilton Lane this month launched its Private Wealth Survey, which found that almost 60 percent of financial professionals intend to allocate at least 10 percent of their clients’ portfolios to private markets in 2025 — 15 percent more than last year. The firm said expectations of technological advancements and an easier regulatory environment are driving the increase.
A joint venture is one route to getting the skills necessary to create private funds for retail and make sales, as it may preclude the issues that arise from cultural differences between alts and traditional firms.
Elliott suggests that the days of private funds being open only to institutions are quickly coming to an end. This is true even though there’s a big difference between mutual funds, which are highly regulated and whose holdings are fully transparent to investors, and private funds, whose terms are often directly negotiated between managers and institutions.
“It’s all about who has what skill set. If you’re Apollo, you don’t have a lot of skill set in ‘40 Act product management, but [you’ve] built lots of private funds,” Elliott explains. “The 40 Act space is its own entity; there are a set of skills and understanding and execution abilities . . . that a lot of these institutional managers just don’t have.” On the other side, traditional managers don’t have experience with performance fees and other structures. “They don’t have any of the 2-and-20 skill set.”
Private equity firms are essentially outsourcing people with these skills to help build the next generation of actively managed products. Hiring new teams to manage this work is time-consuming and expensive.
The JVs also provide a bit of cover. Both alternative and traditional firms likely are justified in protecting their reputations; alts firms may not want to come across as mainstream or unsexy, and traditional managers will be unwilling to appear too fee-hungry. Traditional firms that build out a separate team with higher fee products — and higher comp — could also cause problems internally, as nobody wants to make less money than their neighbor.
“There’s reputational distancing for the 2-and-20 asset managers. Instead of serving as the primary adviser to the fund, they serve as subadvisor or an index provider, where they’re an arm’s length away,” Elliot added. “So if things go awry, it doesn’t necessarily challenge their brand name in the way that an in-house product might do.”
There is little clarity about exactly how the partnerships will function. Joint ventures based on collaboration beg the question of what will happen when there is trouble in paradise; fee sharing, for example, could create friction. Similarly, ideological differences or just poor fund performance could cause problems down the line.
Meghan Neenan, the North American head of nonbank financial institutions at Fitch Ratings, notes that because these tie-ups are so new, only time will tell. But reputational damage is something to watch out for.
“The ones that have been announced have been highly recognized names, good platforms on both sides,” she says. “But certainly, there’s the risk that the product doesn’t perform up to par and you get high redemptions in these products because there is the ability to redeem a certain portion of the assets.”
The products will help traditional firms’ fee revenue, which has long been under pressure by investors opting for low-cost index funds rather than higher-cost active ones. Alts firms need to expand their client base as institutions could potentially max out their allocations to private markets over the next few years. And the fees could stay high for quite a while, helping both sides. “These hybrid products are new, and I think they’ll hold the line on fees for the time being. There’s not a lot of supply on this type of investment in the market today.”
In terms of client relationships, she says in the case of a split, there shouldn’t be issues over institutions as both parties will bring new ones to the table. With retail clients, this may be more difficult because traditional firms are strong in retail already. But alternative investment managers are only beginning to sell products to individuals, either directly or through advisors. As currently structured, retail clients would remain with the traditional managers, notes Neenan. Alts firms are simply offering access to their products.
In addition, there could yet be regulatory hurdles for these products, although none exist right now . With the current block on new regulations and the business-friendly approach of the new administration in the U.S., the Securities and Exchange Commission or the Financial Industry Regulatory Authority won’t be issuing specific guidance anytime soon, even when the block is lifted.
For now, issues on fee structures and liquidity mismatches give PE firms and other asset managers enough to worry about. Once the creases are ironed out, investors will have much greater choice in the quest for asset class diversification.
