Unleashing investor power through market diversity: rethinking the EU Retail Investment Strategy

Rethinking the EU Retail Investment Strategy

For decades private equity has been an asset class aimed primarily at professional investors. This was not a deliberate choice, but a consequence of the very nature of its long-term investment model. Closed-ended funds managed by venture, infrastructure and private equity managers were set up for 10 years – the time needed to make investments that really helped companies grow. As a result, managers were rarely able to offer their investors redemption rights that matched their investment needs.

This is not to say that private equity has not had a positive impact on M. Dupont & Mrs Smith: they, like others, have enjoyed the returns offered by the asset class through their pensions and insurance products – and have invested their capital in the businesses that private equity supports, from start-ups looking to grow to national champions looking to become international conglomerates.

However, the private equity industry is evolving. More sophisticated managers are looking for ways to allow retail investors to participate in their funds, and new liquidity options have been developed in recent years to give investors the flexibility they need to invest in long-term products. Changes to the ELTIF label are also coming at the right time to incentivise more managers to open the doors of their funds to clients who would have not previously been able to access their funds.

In this context, the publication a few weeks ago of the Retail Investment Strategy, aimed precisely at encouraging retail clients not to leave all their hard-earned money in bank accounts, should surely have been welcomed by the financial services industry as a whole, and by the private equity industry in particular. After all, everyone should agree that, as the first recital of the Directive states, “consumers [must] fully benefit from the investment opportunities offered by capital markets”.

So why is the industry reacting so negatively to the Commission’s proposals?

Let’s be clear from the outset: the objectives set out in the European Commission’s Strategy are the right ones. No good capitalist should disagree with the core idea that investors should get good “value for money” and that they should have the right information to make their decisions.

Rather, the cold reception comes from the way the Commission has approached these issues. Perhaps the cardinal sin of the proposal has been to build its entire framework around the principle that the whole offer to retail investors must necessarily partake the form of standardised products. As a result, all aspects of the proposal are tilted towards the principle that investors are necessarily helpless, difference necessarily means complexity and value necessarily means low fees.

The case of private equity, with the characteristics we described at the beginning of this piece, is a good example of why the Commission’s approach poses a significant risk to the future of EU capital markets. The Commission’s Proposals simply do not fit its core model, which is about active involvement in the running of businesses and has very little to do with traditional index funds.

As a result, new rules on inducements, however limited, will affect the relationship between managers and distributors who can offer their products to retail investors – potentially drying up distribution channels. At the same time, calculating costs at the outset and benchmarking them against other funds may be appropriate for mass-market, open-ended mutual funds – but it misses the point that these funds are bespoke and that comparing them to each other is a very different exercise from comparing one index fund to another.   

Recognising the diversity of markets, rather than trying to impose a one-size-fits-all approach would empower investors by better directing them to the products that are best suited to them. In particular, a more ambitious revision of the definition of professional investor could help to achieve this objective, as a better categorisation of investors would ensure that the stringency of proposals aimed at mass-retail clients does not affect other types of more sophisticated investors.

It is not too late to make the necessary changes to the proposal to better recognise the diversity of structures to which clients can subscribe. For all its flaws, the Retail Investment Strategy does open up an important debate about the interaction between investors and those who offer them products. But for the sake of both, let us hope that this proposal marks the beginning of the debate rather than its end.