Private investment markets – historically the province of institutional investors – are beginning to open their doors to retail participants. This trend, described as the “retailization” of private markets, is evidenced in President Trump’s plans to open private asset funds to 401(k) plans. See Trump Executive Order to Help Open Up 401(k)s to Private Markets. (Throughout this alert, terms such as “private funds,” “private markets,” “private asset vehicles,” and similar are used interchangeably to refer to locked-up strategies that have historically not been offered to the public, such as private equity and venture capital funds.) While the shift presents compelling growth opportunities for sponsors, it raises questions for investors and for the sponsors themselves.
This subject could soon become of critical importance to many groups of Americans, including anyone with a 401(k) plan or investible assets, or anyone managing a private asset fund, an institutional investor, or, perhaps most critically, a corporation’s 401(k) vehicles. This is because current 401(k) rules could expose 401(k) fiduciaries to liability for bad decisions.
Propelling the trend toward retailization of private funds is the fact that private asset managers are generating less fee income for private sponsors from fewer portfolio company exits over the last several years because of higher interest rates and other factors. The drying up of exit opportunities has made it harder to wind down current funds or to start new ones, and the solutions private managers have sought, such as general partner (GP) continuation funds and net asset value (NAV) facilities, have generally been received less than enthusiastically by their institutional clients. Generating fewer fees has meant less income for private managers and more struggle to retain or attract top talent.
In these challenging circumstances, retail markets may appear to offer managers a Shangri-la of sorts:
- With trillions in assets, 401(k) plans and other retail vehicles offer a new avenue of plentiful capital.
- Managers might be able to spend less time and effort fundraising as institutional investor demand has waned, particularly among universities, as they are rather suddenly reallocating endowment funds to address anticipated budget shortfalls from the withdrawal of federal grants.
- Although institutional investors have only so much ability to negotiate terms, retail investors are accustomed to merely making a 401(k) election and having no input on terms at all. As a result, sponsors may hope for greater elasticity on management fee rates, incentive compensation, and expenses.
It is currently unclear how fund sponsors will structure private fund vehicles to accept retail capital. Included among the options would be: to fund the sponsor’s fund stake via retail money; to intermix retail investors and institutional in a single commingled fund; to run parallel funds for retail and institutional investors; or to begin accepting retail money only and jettison institutional capital. Institutional investors may not be able to avoid this last option, although this may present green shoots for institutions seeking newer or early-stage sponsors who do not want or cannot afford the complexities and expenses associated with retail investors.
Other challenge scenarios for institutional investors from retail participation may include the following:
- Institutions expect the manager, as general partner of the investment partnership, to make a significant capital commitment to a private asset vehicle, usually 2% or more in private equity, venture, or similar closed-end strategies. The reason for the GP commitment is to build an alignment of interest with the manager, especially when private funds may permit sponsors to allocate investment capital among the manager’s funds or to favored clients as “co-investments.” However, once a manager has retail dollars, will the manager look to apply the retail money toward its GP commitment rather than its own? If so, how would knowledgeable investors find assurance that there is a commonality of interest?
- Many private asset vehicles currently impose little or no fiduciary duty on managers. As such, managers often may act in their self-interest at their sole discretion, and indeed may place their own interests first. This flexibility arises from the fact that the Investment Advisers Act of 1940, which governs private funds, imposes only a narrow anti-fraud standard of care rather than a traditional fiduciary duty, while Delaware and other state laws permit the waiver of almost all fiduciary duties in fund structures. In short, the courts and Congress have been OK with the lax oversight of private vehicles to date because they have only included “sophisticated” investors.
- On the other hand, 401(k) investment options are governed by the similarly named Investment Company Act of 1940 as well as ERISA, which impose a traditional fiduciary duty on plan fiduciaries. As such, plan fiduciaries are charged with prudent selection and oversight of plan offerings and avoiding overly risky or costly ones. Thus, will plan fiduciaries expect stronger fiduciary obligations from private sponsors than what they currently encounter from institutional investors under the Advisers Act? If so, will this cause divergent outcomes within a commingled fund or across parallel funds, depending on who the investors are in each fund? For example:
- Will GPs feel compelled to pick better or safer portfolio investments for retail funds, or will they overallot the better or safer deals to the disadvantage of their institutional funds?
- Currently, parallel funds routinely function on a pari passu and pro rata basis regardless of investor composition. But will the fiduciary duty a manager owes to retail vehicles or the liquidity demands of the retail market result in retail investors getting better terms going into or out of portfolio investments?
- Many retail investors expect daily or regular liquidity, and the illiquidity of private equity, venture fund, and other closed-end strategies may invite questions. Will plan fiduciaries be as patient with J curves and the standard five-year investment period as institutional investors? Could this alter manager thinking on its risk tolerance for earlier-stage or longer-term portfolio investments, or force managers to hasten exits at suboptimal terms?
- Will the need to provide liquidity to 401(k) plans force managers to establish larger borrowing facilities for their fund vehicles to allow limited redemption rights to these investors?
- The public disclosure obligations for retail vehicles could result in the release of sensitive information about fund performance, portfolio holdings, or even the identities of other limited partners. How might that affect the fund’s investment strategy or willingness to pursue certain transactions?
- Will the GP undertake fewer self-dealing transactions or pull back on questionable expenses in order to attract retail funds? For example, many managers currently charge their funds not only a management fee but also a fee for the manager’s internal accounting, audit, legal, and other back-office services, usually at a profit. Many also charge for Bloomberg access, software, and other costs that, to the uninitiated, may appear plainly to be management expenses that should be covered by the management fee, which often can amount to millions of dollars annually.
- Lastly, will 401(k) fiduciaries, for example, look less warmly on expense provisions covering private jet travel, the manager’s “entertainment” expenses, or “gifts”? Similarly, will 401(k) fiduciaries be comfortable with the many venture capital funds that subordinate the management team’s duties to their personal pursuits, including their personal portfolios and charitable endeavors?
- Down the road, will Congress and the courts notice these divergencies and wish to revisit the relative lenience of the Investment Advisers Act in terms of sponsor obligations and overreach on terms? Or, at the other extreme, will they look to eliminate or reduce managers’ fiduciary duties under the Investment Company Act?
- What if 401(k) fiduciaries fail to match the enthusiasm of private fund marketing teams? Will private fund managers lobby Congress and the President to reduce the minimum net worth or annual income requirements for 401(k) participants or reduce or eliminate fiduciary duties of 401(k) managers under ERISA?
- Although there are legal and business reasons why institutional investors rarely sue managers; 401(k) participants are free to and often do sue plan fiduciaries. It is not hard to imagine retail investors professing surprise in hindsight at the hefty fees, illiquidity, and risk of private fund strategies,. If so, will these lawsuits spill over into plan fiduciaries suing fund sponsors? Will this area of litigation spawn a new plaintiffs’ bar akin to those of personal injury firms?
For these reasons, we wonder whether the addition of retail money will be as smooth and easy as perhaps some private asset managers are hoping.
What about the retail investors, including those who participate in employer-sponsored 401(k) plans or rollover IRAs, or who have other investible assets? How should they be thinking about private strategies in their personal accounts? The questions may include:
- If you are considering investing in a private fund, do you meet the suitability requirements generally required by institutional-quality funds? At a minimum, these standards will most often require a $2.2 million net worth and could require you to have investment holdings of at least $5 million.
- How much do you understand the business of private asset investments, including the illiquidity, costs, and risks?
- Does your retirement plan or broker place a limit on dollars or percentage of participant accounts in private equity? If not, what should be your risk horizon?
- Are you capable of waiting through the fund’s long investment and harvesting periods? Can you lock up the money for five to 10 years? If you are nearing retirement age, for example, the illiquidity aspect may affect the decision or the magnitude of the commitment.
- What is the track record of private equity or other closed-end managers who are offering their products to you? Are their track records in the top quartile of their investment classes, or is the history less impressive? Or was the fund recently formed by a brokerage firm or a mutual fund family without a track record in private assets or with a team who are new to private asset management?
- What are the fees and expenses? Are they reasonable versus public equities or peer private funds? What are the historical or projected returns to investors post-fees?
- Will reporting content from private sponsors be satisfactory?
Finally, as noted above, Congress and the courts have generally shied away from regulating private asset funds on the basis that their institutional clients are “sophisticated” and thus capable of understanding the risks of, and their limited rights under, private fund agreements. Query whether the government will be as sanguine if and when retail investors begin to complain about fees, lack of transparency, and lack of voting rights regarding private funds, especially those that fail to perform as expected.
In-depth 2025-202
