Retail Access to Private Markets

Discover how retail private funds' reported low volatility may mask actual risk and implications for investors and policymakers.

Paper reviewed:

Bates, Benjamin, Retail Access to Private Markets (July 31, 2025). Available at SSRN: https://ssrn.com/abstract=5381902 or http://dx.doi.org/10.2139/ssrn.5381902

Summary

This research paper examines retail access to private markets, revealing that retail private funds, such as BDCs and non-traded closed-end funds, may understate their actual risk despite reporting low volatility. The study also finds that funds sold to wealthier investors perform better than those sold to retail investors, and that fees are significantly higher than traditional mutual funds.

Key Findings

Implications

Business and Policy Implications

Introduction

The rise of retail private funds has been driven by the growing demand for access to private markets, fueled by narratives that private markets offer better investment opportunities and that public markets are shrinking. Private fund sponsors have responded by creating products that combine features of private and registered funds, making them accessible to retail investors. However, these new products pose significant risks to retail investors, including the potential for underreported volatility and adverse selection.

Background and Context

Historically, the U.S. securities markets have been divided into public and private spheres, with public investments being heavily regulated and available to everyone, while private investments are reserved for wealthy and sophisticated investors. The growth of private markets has led to concerns that retail investors are missing out on important investment opportunities. Recent years have seen the emergence of new financial products designed to provide retail access to private markets, primarily through structures like BDCs and non-traded closed-end funds.

Relevant Industry Context

The number of public companies has declined over the past two decades, while private markets have grown significantly. This trend has sparked interest in expanding retail access to private markets. However, private fund investments are often characterized by illiquidity and high fees, posing challenges for retail investors.

Previous Research and Current State of Knowledge

Research has shown that private equity and venture capital funds have generally performed well, but with varying degrees of success over time. The literature also highlights concerns about the transparency and risk associated with private fund investments.

Why This Research is Needed

This research is necessary to understand the risks associated with the new retail private funds and to inform policymakers on how to protect retail investors while facilitating access to private markets.

Background on Private Securities Markets

The distinction between public and private markets is rooted in U.S. securities laws, particularly the Securities Act of 1933 and the Securities Exchange Act of 1934. Public companies are subject to stringent disclosure requirements, while private companies can avoid these requirements by limiting their investors to accredited investors. Investment funds are also divided into public (registered) and private funds, with private funds being restricted to sophisticated investors.

Public and Private Companies

Public companies are those whose securities are registered with the SEC and are available for public trading. Private companies, on the other hand, sell securities through private placements, typically to accredited investors.

Public and Private Funds

Registered funds, like mutual funds, are available to the public and are heavily regulated. Private funds, including private equity, venture capital, and hedge funds, are restricted to sophisticated investors and have fewer regulatory requirements.

Getting Retail into Private Markets

Private fund sponsors have launched new products that blend characteristics of private and registered funds to provide retail access to private markets. These products are primarily structured as BDCs and non-traded closed-end funds.

BDCs

BDCs are required to invest at least 70% of their assets in private companies or small-cap public companies and offer significant managerial assistance to their portfolio companies. They can be structured as public, non-traded, or private BDCs, each with different distribution channels and regulatory requirements.

Non-traded Closed-end Funds

Non-traded closed-end funds come in two main flavors: tender offer funds and interval funds. Both types periodically offer to repurchase shares at NAV, but interval funds commit to a set repurchase schedule, while tender offer funds do not.

What Are the Risks?

The empirical evidence suggests that retail-focused private market investment funds pose two main risks to retail investors: underreported volatility and adverse selection.

Performance: Returns and Volatility

BDCs have delivered attractive reported returns with low volatility, but this performance may not accurately reflect their true risk. The actual performance of publicly traded BDC shares has been much more volatile than their reported returns.

Unsmoothing Returns

A simulation analysis suggests that if BDCs' investments were marked more closely to public market fluctuations, their risk-adjusted performance would be significantly less attractive.

Comparing Performance Among Fund Types

Private BDCs have outperformed non-traded BDCs, even after controlling for fund size and leverage. This difference may be driven by differences in gross returns rather than fees.

Policy

To address the risks associated with retail private funds, policymakers could consider several reforms.

Inadequate Disclosure of Investment Volatility

The SEC could improve disclosure practices by requiring funds to report investment values that accurately reflect market conditions. This could involve more scrutiny of valuation practices and additional disclosures about valuation assumptions.

Worst Investments Sold to the Least Sophisticated Investors

To mitigate adverse selection, policymakers could streamline product offerings and improve fee transparency. Allowing retail investors to access private funds through their retirement accounts could also help.

By addressing these risks and implementing thoughtful reforms, regulators can help protect retail investors while facilitating innovation in the retail private fund space.

Main Results

The paper examines the rise of retail private funds, which provide individual investors with access to private markets. The main findings are presented below.

Performance of Retail Private Funds

The data show that Business Development Companies (BDCs), a type of retail private fund, have delivered attractive returns with low volatility. Figure 8 plots the cumulative returns of three BDC indices from 2015 to 2024, showing that public and private BDCs outperformed the ICE BofA High Yield Index.

Risk-Adjusted Performance

Figure 9 presents the average return and volatility of BDC indices, revealing that public and private BDCs have high Sharpe Ratios due to their high returns and low reported volatility. However, the actual performance of publicly traded BDC shares differs significantly from their reported returns, with much higher volatility.

Comparison with Public Markets

The Fama-French three-factor model is used to estimate the degree to which BDC indices are correlated with public markets and their over- or under-performance. Table 3 shows that all BDC types have demonstrated outperformance, with private BDCs outperforming by almost 5.6 percentage points per year.

Unsmoothing Returns

A simulation analysis is conducted to estimate the risk-adjusted performance of non-traded and private retail private funds if their asset values fluctuated with public markets. Figure 11 plots the reported and simulated cumulative returns of private and non-traded BDCs, showing that the simulated indices have much higher volatility.

Comparison Among Fund Types

The data suggest that private BDCs perform better than non-traded BDCs, even after controlling for fund size and leverage. Table 4 reports the results of a regression analysis, showing that private BDCs outperform non-traded BDCs by 3-4 percentage points per year.

Methodology Insights

The research approach involves analyzing data from SEC filings of BDCs and non-traded closed-end funds. The dataset includes quarterly financial variables, such as total assets, liabilities, and net investment income, as well as more granular data on fund fees and performance.

The use of the Fama-French three-factor model and simulation analysis provides a robust framework for evaluating the performance and risk of retail private funds. The findings highlight the importance of considering the actual performance of publicly traded BDC shares and the potential for adverse selection in the retail private fund space.

Analysis and Interpretation

The results have significant implications for retail investors and policymakers. The low reported volatility of retail private funds may be misleading, and investors may be exposed to higher risks than they anticipate. The performance gap between private and non-traded BDCs raises concerns about adverse selection, where worse-performing products are sold to less sophisticated investors.

To mitigate these risks, policymakers could consider reforms such as improving disclosure practices, streamlining product offerings, and enhancing fee transparency. Allowing retail investors to access private funds through their retirement accounts could also help.

The findings also highlight the need for further research on the retail private fund space, including the impact of fees on investor returns and the potential for adverse selection. By addressing these issues, regulators can help protect retail investors while facilitating innovation in the retail private fund space.

Practical Implications

The results have practical implications for business leaders and investors. Retail private funds may not be as low-risk as they appear, and investors should be cautious when investing in these products. Fund sponsors and distributors should also be aware of the potential for adverse selection and take steps to ensure that investors are properly informed about the risks and fees associated with these products.

Strategic Recommendations

To minimize risks and maximize returns, investors and fund sponsors can take several steps:

By taking these steps, investors and fund sponsors can work together to create a more transparent and equitable retail private fund market.

Practical Implications

The rise of retail private funds has significant implications for investors, fund sponsors, and policymakers. As retail private funds continue to grow in popularity, it is essential to understand their practical implications.

Real-World Applications

Retail private funds are being used to provide investors with access to private markets, which were previously inaccessible to them. These funds are being marketed as a way to "democratize" private markets and give savers an unprecedented opportunity to diversify their portfolios and earn attractive returns.

Strategic Implications for Businesses and Managers

The growth of retail private funds has significant strategic implications for businesses and managers. Fund sponsors are using these funds to capitalize on the demand for private market investments from retail investors. To succeed in this space, fund sponsors need to be aware of the potential risks and take steps to mitigate them.

Who Should Care About These Findings and Why

Investors, fund sponsors, and policymakers should all care about the findings related to retail private funds. Investors need to be aware of the potential risks associated with these funds, including the risk of underreported volatility and adverse selection. Fund sponsors need to be aware of the regulatory requirements and the need to provide transparent disclosure to investors. Policymakers need to be aware of the potential risks and benefits associated with retail private funds and take steps to ensure that investors are protected.

Actionable Recommendations

To minimize risks and maximize returns, investors and fund sponsors can take several steps:

Improve Disclosure Practices

Fund sponsors should provide more accurate information about investment volatility and fees. This can be achieved by:

Streamline Product Offerings

Fund sponsors can reduce complexity and enhance transparency by:

Enhance Fee Transparency

Fund sponsors should provide clear and transparent information about fees, including:

Consider Allowing Retail Investors to Access Private Funds Through Retirement Accounts

Allowing retail investors to access private funds through their retirement accounts could help reduce the risk of redemption requests during downturns.

Conclusion

The rise of retail private funds has significant implications for investors, fund sponsors, and policymakers. To minimize risks and maximize returns, it is essential to improve disclosure practices, streamline product offerings, enhance fee transparency, and consider allowing retail investors to access private funds through retirement accounts. By taking these steps, we can create a more transparent and equitable retail private fund market.

Summary of Main Takeaways

Final Thoughts on Significance and Impact

The growth of retail private funds has the potential to significantly impact the investment landscape. By providing investors with access to private markets, these funds can help democratize access to alternative investments. However, it is essential to be aware of the potential risks and take steps to mitigate them. By doing so, we can create a more transparent and equitable retail private fund market that benefits investors and fund sponsors alike.