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A high-stakes race is taking shape between major money managers including BlackRock and Invesco to combine Wall Street’s most trendy investment vehicle with its fastest-growing asset class.
The firms are among those signalling that they want to offer access to private markets via exchange-traded funds (ETFs), a tie-up with the potential to open the closed-off world to investors of all stripes. It could also channel fresh cash into an asset class struggling to keep the boom alive after years of breakneck expansion.
The challenge? Even these investing behemoths will need to overcome a slew of technical and regulatory hurdles before they can squeeze the likes of real estate and pre-public companies into the famous ETF wrapper.
“It won’t be quite so linear as, well, go buy a bunch of buildings and smack them into an ETF,” said Doug Sharp, Invesco’s head of Americas and EMEA, who confirmed his firm is exploring the idea. “I would expect innovation in the space, but the path there is a bit less clear.”
With private markets now worth more than US$13 trillion and billions pouring into ETFs every month at the expense of old-fashioned mutual funds, the motivation to figure it out is strong.
BlackRock’s US$3.2 billion deal to buy Preqin, a provider of alternative-asset data, is part of the firm’s ambition to “index the private markets”, chief executive officer Larry Fink said after the acquisition was announced in early July. The world’s largest money manager believes it can bring the principles of indexing and iShares – its ETF arm – to the industry, Fink said. Preqin competes with Bloomberg LP, the parent of Bloomberg News.
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While it may not happen in the near term, “the ETF-like wrapper for private assets could be very important to investors in the future”, Samara Cohen, BlackRock’s CIO of ETF and index investments, told Bloomberg TV’s ETF IQ recently. “We’ve given a lot of thought to what is the extension of our ETF and indexing capabilities that we’ve built into private markets.”
Meanwhile, Apollo Global Management, a US$671 billion alternative-asset manager, has said it plans to sell private credit through retail channels including ETFs. Goldman Sachs Asset Management says it’s mulling how a private-assets ETF might work.
The big challenge is figuring out the liquidity mismatch between the assets and the vehicle. As listed securities, ETFs change hands every second of the day in the cash market, in extended trading, and increasingly even overnight. In contrast, private investments are infamous for barely trading at all.
“By definition, alternatives are illiquid and ETFs, the whole core to it is liquid,” said Marc Nachmann, Goldman Asset’s global head of asset and wealth management. “I think lots of people, including ourselves, are thinking through how that could work.”
While the resilience of fixed-income ETFs during the Covid crash alleviated fears over funds that hold less liquid assets, the scale of the mismatch with private investments would have little precedent.
The Securities and Exchange Commission puts a 15 per cent limit on open-ended funds holding illiquid investments, defined as those that can’t be sold in seven days “without significantly changing the market value of the investment”. That effectively caps an ETF’s direct private-asset holdings, meaning at present it can only hold a dollop of unlisted exposure.
One potential solution to the mismatch is via so-called synthetic exposure, whereby a fund wouldn’t actually hold private assets but would contain swaps written against a private equity portfolio.
“Ultimately the swap still has to be valued based on some kind of mark every single day,” said Dave Nadig, an industry veteran who says he’s had countless conversations over the past two years with firms looking to create a private-assets ETF. “That makes this extraordinarily sloppy.”
Another option would be to attempt to mimic the performance of private-asset investments in a so-called liquid alternative ETF. These funds, known as liquid alts, use tactics like leverage, short selling and derivatives to replicate strategies, often trying to ape popular hedge fund styles.
Their running costs and checkered performance have drawn criticism, and there’s a big question over whether private markets – where valuations are often only updated quarterly – have enough data to create a viable liquid alt strategy. Nonetheless, they’ve proved a powerful tool for opening up sophisticated approaches that were previously off-limits to most investors – much like unlisted assets are.
“The retail community has been shut out from the wealth generation of private assets,” said Reggie Browne, the head of ETF trading at market-maker GTS. The industry veteran cites the example of Uber Technologies, which grew tremendously in the years before it went public. “All that market-cap expansion was not available to retail,” he said.
There are currently at least 15 ETFs that seek to offer some private-market exposure in the US, according to JPMorgan Chase, but they mainly do so indirectly, targeting things such as initial public offerings and special-purpose acquisition vehicles.
Underscoring that trend, KraneShares in July filed for a new fund that will track an index offering private equity performance. But that will be achieved using listed small and mid-cap stocks the issuer sees as being similar to the kind of companies in buyout funds.
Cynics see another motivation behind the race to let individual investors join the private-market party.
With interest rates at the highest level in years, pressure has been building on buyout firms as they grapple with elevated borrowing costs and struggle to exit assets at decent prices. Against that backdrop, fundraising for private equity is on course for a 20 per cent decline this year, according to S&P Global Market Intelligence and Preqin.
Some market players fear attempts to help individual investors access the industry are little more than an effort to keep the boom alive.
“A lot of the money that’s in big institutional-darling hedge funds and venture cap funds is trapped,” Nadig said. “The whole idea of putting their exposure into ETFs is mostly about figuring out how to foist all of this private equity onto the retail market so institutions can go back to the game of funding new companies.”
Yet with the amount of cash in private assets projected to total almost US$20 trillion through 2028, according to PitchBook, the endgame is surely inevitable.
Despite various practical challenges, the ETF industry has ultimately managed to squeeze everything from collateralised loan obligations to complex tax-efficient strategies into the wrapper. Issuers even successfully launched leveraged single-stock products in the face of vocal opposition from the SEC.
“If it can be done, I have the confidence in the ETF market,” Todd Rosenbluth, head of research at the indexing and analytics firm VettaFi, told Bloomberg TV’s ETF IQ. BLOOMBERG
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