Retail investors are getting more access to opaque private markets, and it’s raising risks.
The activity could also be a systemic threat to the broader financial system, Moody’s said.
Private markets are less liquid than their public counterparts, but retail investors want quick access to funds.
Retail investors are increasingly being offered access to private markets as investing heavyweights compete for their business. But the shift has created a host of risks for individuals and the broader financial system.
That’s the takeaway of a new report from Moody’s, which warned of “systemic implications” as ETFs and retirement funds facilitate a flood of money from individual investors.
Once reserved for the investing world’s elite echelons, the booming private equity and private credit markets are slowly being opened up to Main Street investors. The development has sparked some debate about the wisdom of offering everyday people access to illiquid, complex investments.
The report from Moody’s comes as the $1.4 trillion market for private equity and credit investments has exploded in recent years. As public listings have dried up, more companies have turned to private markets for funding; however, investments from institutional investors are slowing, driving the big players to look for new frontiers.
In recent months, giants including BlackRock, State Street, KKR, and Apollo have unveiled ETFs, target date retirement funds, and other investment vehicles aimed at Main Street — and there’s reason to be wary, Moody’s said this week.
Illiquid and complex
Among other risks, a flood of new money into the space could set off a race among money managers to deploy capital, the firm said.
“If competition for retail capital outpaces the supply of quality assets, and if growth outpaces the industry’s ability to manage these complexities, such challenges could have systemic consequences,” Moody’s analysts wrote.
“Some managers may be tempted to compromise on underwriting standards or stretch into riskier assets to keep pace with inflows and capitalize on the opportunity.”
What’s more, retail investor participation risks heightening volatility in times of market stress, and the market itself is less liquid and more complex than stocks.
One of the big draws of the stock market for investors is that you can buy or sell shares at a moment’s notice. Not so with private investments, which don’t necessarily have “mark to market” valuations.
“One of the most pressing concerns for ‘Main Street’ investors is liquidity and the inherent lack of it in private markets. Retail investors often require quicker access to their capital and have less long-term investment flexibility,” Moody’s wrote.
The ratings agency points to the Great Financial Crisis, when people turned to their 401(k)s for cash while the economy soured. In such a situation, if money is locked up in private market investments, people could have trouble accessing their money.
“In volatile markets, retail investors may run for the exits, which would exacerbate liquidity needs and the risk of potential mismatches between a product’s available liquidity and what investors are expecting.”
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