The tumult across global financial markets triggered by President Donald Trump’s trade war overshadowed the release last week of Larry Fink’s latest letter to investors, possibly the most far-reaching message penned so far by the CEO of the world’s largest asset manager, BlackRock Inc. (BLK).
The letter presents a radical vision of the future for ordinary investors.
Central to this is Fink’s belief that unlocking access to illiquid private markets for everyday investors is essential to solve the pension crisis facing ageing populations worldwide and to meet huge new global infrastructure investment requirements estimated at $68 trillion by 2040.
Bringing Private Assets to Individual Investors
Institutional players—U.S. state pension funds and university endowments along with sovereign wealth funds—have long employed large allocations to private equity, infrastructure and real estate as core building blocks in their portfolios in an effort to earn higher returns.
A huge push has been building among private fund managers and their lobbying groups to allow everyday investors to have easier access to these illiquid, opaque strategies. Many traditional fund managers have also started to build or expand their private market capabilities and have joined the lobbying campaign for greater retail investor involvement.
In his letter, Fink suggests that the future standard investment portfolio could be split into 50% equities, 30% bonds and 20% private assets instead of the conventional 60/40 stock and bond mix, which has historically provided the cornerstone of millions of retirement savings accounts.
Tokenization Transforms Private Markets
The advent of tokenization could accelerate the shift into private markets. Turning a small stake in an infrastructure or property project into a digital token that lives on a blockchain and is tradable online could help everyday investors to access private markets, which are currently restricted to institutional players and wealthy individuals.
These digital tokens for private assets could also be combined into multiple flavors of new ETFs, potentially opening a vast new channel for ETF industry growth. Tokenization, according to Fink, will eventually make investing in private markets as simple as buying an S&P 500 ETF or index-tracking mutual fund.
Fink readily admits that his letter is an unabashed advertisement for BlackRock, which has already begun to reposition its business in anticipation of a bigger shift into private markets, as they command higher fees than investments in publicly traded stocks and bonds. Another attraction for an asset manager, such as BlackRock, is that investors’ money cannot be withdrawn on short notice from private market strategies, so any fees collected are “sticky,” which helps to stabilise their earnings.
BlackRock's Big Bet
Evidence of the huge scale of Fink's ambitions in private markets was provided by three deals worth a combined total of around $27 billion completed last year by BlackRock to acquire specialist infrastructure manager Global Infrastructure Partners, private credit manager HPS Investment Partners and private markets data provider Preqin.
Other large ETF providers are also exploring the possibility of new partnerships with private market managers. Discussions have been held between Pennsylvania-based Vanguard, the world’s second-largest asset manager, which is widely regarded as a very cautious organisation, and private equity managers Carlyle Group Inc. (CG) and Blackstone Inc. (BX), according to Bloomberg.
State Street Global Advisors partnered with private equity manager Apollo Global to launch the SSGA IG Public & Private Credit ETF (PRIV) in February, which can hold up to 35% of its assets in private credit.
Any Apollo-run private credit investments held by the ETF can be repurchased by Apollo in its role as a liquidity provider to the fund. This created a clear conflict of interest, with Apollo acting as the buyer, seller and pricing agent for Apollo private credit assets held by the PRIV ETF. This arrangement rang alarm bells at the Securities and Exchange Commission, leading the regulator in a highly unusual move to flag its concerns about the ETF’s ability to comply with valuation rules.
The Complexity of Private Assets in ETFs
There is no neat solution currently available to ETF managers that want to invest in illiquid private credit to the issues raised by the SEC. Private credit—loans—do not trade and are not mark-to-market on a daily or intra-day basis. This creates uncertainty about the accuracy of the net asset value of an ETF that holds private credit loans.
Similar difficulties exist for any ETF manager that wants to invest in private equity assets. Private equity managers insist that they use conservative net asset value (NAV) estimates during the period when they own a company, which allows them to book a valuation uplift when that asset is sold. This raises questions about whether an investor can be confident that they are receiving a fair deal when buying or selling an ETF that invests in private equity when the underlying assets do not trade and the valuation is made by the manager and not an independent third-party.
Does Private Equity Really Outperform?
Private equity managers routinely boast that they deliver superior returns to publicly traded stocks, but these claims have been questioned by some academics. The internal rate of return (IRR), the most widely used performance metric among private equity managers, is not directly comparable to the returns data reported by publicly traded stocks and bonds. Private equity managers also frequently use financial engineering tricks, such as subscription lines and NAV loans, which have impacts on the valuations of their portfolios.
Fink clearly believes that tokenization can solve the complexities associated with private market investing which have deterred regulators from allowing wider retail investor participation. But whether the advent of tradeable digital tokens can accurately reflect the true value of investments in infrastructure, real estate, private equity and private credit when these assets trade very rarely is still debateable.
The engineers at BlackRock still have a lot of work to do to transform Larry Fink's plans to democratise access to private markets into a reality.
This article was originally published at etf.com sister publication ETF Stream.
