Financial advisors might want to pay closer attention to what presidential hopeful Senator Elizabeth Warren (D-Mass.) has proposed that could potentially create consequences for their clients as her standing in the polls has risen after her strong debate performances.
Warren’s newest “I’ve got a plan for that” focuses on the private equity sphere.
“She’s pretty much proposing a total revamping of the way private equity firms do business,” Robert Willens, a New York-based tax analyst and a former managing director at Lehman Brothers told the Washington Post. “She didn’t miss anything, that’s for sure.”
Under her proposal, a bill she and other congressional sponsors have called “Stop Wall Street Looting Act of 2019,” PE fund managers would become legally on the hook for the actions and liabilities of the companies they control. What that means in practical terms is that under the proposal, fund managers could be sued for a controlled company’s debts, including pension obligations, and for any of its violations of federal laws.
“Anyone remember Sears? Anyone remember Toys R Us?” Warren asked an audience recently, seeking a show of hands. Those companies and others went bankrupt after PE funds invested in them, Warren explained. PE fund managers “suck up value, line the pockets of the private investors, and leave the workers and communities behind,” she added.
Warren’s perspective on PE differs greatly from that of SEC Chairman Jay Clayton, a Trump appointee who has said his agency wants to help Main Street investors get in on the high returns delivered by the PE funds.
“The private markets are awash in capital these days,” Clayton told an audience of entrepreneurs and business-school students in a speech delivered last year. “The question is, who is participating?”
Clayton is correct about the availability of capital for PE fund investing. According to Bain Capital’s 2019 report, the total buyout value of deals in 2018 jumped 10% to $582 billion (including add-on deals), “capping the strongest five-year run in the industry’s history.”
But who is participating in the PE investment sphere? Is it Main Street investors, or even the UHNW clients of wirehouses?
Not as many of those wirehouse UHNW clients as one might suspect, based on their wealth. One wirehouse top manager, who did not want to be quoted by name, told reporters recently that even his employer’s UHNW clients are “underinvested” in illiquid and alternative assets. Those asset classes equal only 2% of total client assets, apparently.
“We do zero private equity,” says Joseph Birkofer, a financial advisor at the RIA Legacy Asset Management in Houston, which has more than $500 million under management and a brokerage and clearing arrangement with Charles Schwab Institutional. “It’s a high-risk asset class and it requires intense focus to get it right. You need to be a specialist in advising on private equity,” he says.
But, as a rule, Birkofer says: “I really don’t think presidential candidates have the competency to judge what is appropriate for America’s investing public. The market drives that kind of information.”
In some ways the SEC’s Clayton and Warren are “two different sides of agreement on a point but with different motivations,” Birkofer says. Clayton wants more transparency so Main Street investors can safely acquire stakes in the PE world; Warren wants transparency so fees and any undue profiteering are exposed and stripped away from managers and investors if those gains come at the expense of communities and workers, Birkofer says.
“For those clients with the ability to take in the illiquidity risk, then that is one of the only ways for an advisor to add value,” Lynn McIntire, a registered principal with Raymond James Financial Services and principal of Cadent Capital in Dallas, says about PE investments. “Carefully researching the PE options and explaining the risk and reward trade-off,” offers a way for advisors to add value, argues McIntire, whose firm has more than $300 million in assets under management.
Meanwhile, Clayton will find plenty of company when he bemoans Main Street investors’ limited access to the PE market.
“Unless the inequitable lack of access to private markets is addressed, retirement savers will continue to be deprived of the ability to participate in high-growth business models and further promote the sense that markets are being operated for the benefit of well-connected ‘insiders.’ That surely will not be a resoundingly positive message in these populist times. And those many Main Street investors will be driven away just when they need investment returns the most,” Paul Smith, president and CEO of the CFA Institute, wrote in a recent article.