Retail Access for Private Markets

The U.S. securities laws divide investment opportunities between public markets, in which anyone can invest, and private markets, which are open only to the wealthy. Today, many of the buzziest investment opportunities—including everything from private equity and private credit funds to direct investments in hot tech startups like OpenAI and SpaceX—are available only in the private markets.

As the private markets have grown, retail investors have become increasingly interested in gaining access. At the same time, politicians, policymakers, and investment managers have become more and more willing to find ways to give them access. Just last Thursday, President Trump issued an executive order aimed at making it easier for individuals to invest in “alternative assets,” in their 401(k)s. The SEC has also been evaluating ways to expand private market access.

In a new paper, I study investment funds that offer retail investors access to private investments. These “retail private funds” have multiplied over the past 5-10 years, and they are poised to become an increasingly important part of the investing landscape. Retail private funds are typically structured as registered closed-end funds or business development companies (BDCs). Their shares often do not trade on a stock exchange, and they provide liquidity to investors through periodic share repurchases. Most retail private funds today offer access to private credit investments, though a smaller number offer access to private equity, infrastructure, and other investment types. Retail private funds also generally have much higher fees than traditional mutual funds and ETFs.

Using data from the SEC filings of funds structured as BDCs, I study the funds’ performance and highlight two potential issues for unwary retail investors. First, I show that BDCs’ reported returns—which are based on their estimated net assets values (NAVs)—exhibit exceptionally low volatility, especially given the nature of the funds’ underlying investments and the funds’ use of leverage. These reported returns may lead retail investors to underestimate the funds’ risks. Second, I show that non-traded BDCs sold to less wealthy individuals have lower returns on average than private BDCs sold only to wealthier individuals. This finding raises the concern that individuals with modest means who participate in private markets may predominantly be sold products with below-average performance.

Concern #1: Retail Private Funds Are Riskier Than They Appear

In the paper, I show that, from 2015 to 2024, BDCs reported higher returns than (or at least similar returns to) a portfolio of publicly traded high yield bonds, but with lower volatility. This result is striking because BDCs predominantly invest in high-yield loans to small and medium-sized private companies and use substantial leverage. Interestingly, among BDCs that have publicly traded shares, the funds’ actual, trading returns are more than 4x more volatile than their reported returns.

While the low volatility of these funds reported returns may be striking, it is consistent with typical private market practices. It is no secret, for example, that traditional, non-retail-focused private equity funds report interim returns with low volatility, and in fact, this low reported volatility has been touted as a selling point for investors. Private funds are able to report returns with low volatility because their reported returns are based on periodic estimates of what their investments are worth, not volatile public market prices.

The problem is that, regardless of whether stable NAVs are a problem in traditional private funds, they could be a big problem for retail investors in non-traded funds that offer periodic liquidity. The reason is that retail investors might not fully grasp that stable NAVs offer no assurance that they will be able to cash out their investments at their reported valuations or even that they will be able to cash out at all. If investors rush to withdraw their money during a prolonged downturn, a fund manager has to either (1) sell assets at a loss to fund withdrawals or (2) sharply limit withdrawals. These options would either hand retail investors surprising losses or leave them cash poor at an inopportune moment.

Concern #2: Do the Least Wealthy Investors Get the Worst Funds?

In the paper, I also study differences in performance across funds that are sold to different types of investors. Specifically, I test whether private BDCs, which can be sold only to investors who make at least $200,000 per year or have a $1 million net worth, perform better than non-traded BDCs, which have similar characteristics but can be sold more broadly. I find that private BDCs do, in fact, report substantially higher returns than non-traded BDCs, to the tune of about 68 basis points per quarter, or 2.7 percentage points per year.

What explains this gap in performance? One possibility is that private BDCs tend to invest in riskier assets than non-traded BDCs, so their superior returns reflect compensation for taking on extra risk. I am not able to rule this explanation out, though I note that private BDCs’ reported returns are actually less volatile than non-traded BDCs’.

Another, more concerning, possibility is that retail private fund sponsors are selling worse performing products to less wealthy investors. Sponsors might be able to do this if less wealthy investors are less discerning than wealthier investors about the quality of the investments they are buying.

What Can Be Done?

I conclude the paper by discussing steps the SEC could take to mitigate the risks to retail investors that may be present in retail private funds. First, I discuss ways to make sure that funds’ reported asset valuations accurately reflect what those assets might be sold for in a market transaction. This change would make it easier for investors to gauge retail private funds’ risk profiles and reduce frustrating surprises when market downturns coincide with increased redemption requests. The SEC could move funds’ practices closer to the ideal by more closely scrutinizing funds’ valuation practices during examinations and perhaps by requiring firms to disclose more information about their valuation assumptions or model backtests.

Second, I discuss ways to improve the quality of the investments available to retail investors. By increasing the informativeness of performance and fee disclosures, the SEC could help retail investors better understand the level of performance they are paying for, which might reduce demand for mediocre funds. Additionally, the SEC could reduce sponsors’ incentives to create different products for different investor groups by equalizing the costs associated with launching funds for different investor groups and by streamlining the assortment of structures with differing legal requirements.