Free Market

How We Can Restore Balance to the Financial Ecosystem

This article was authored by research intern Rory O’Meara.

In today’s markets, the uncertainty average investors face is notably different than before. If retail investors are going to keep pace, they need to access investments thought to be reserved for the top echelon. 

During inflationary periods and recessions, conventional investment wisdom tells us that the retail investor should put their savings into bonds, blue chip stocks, real estate, or gold. These investments tend to limit and diversify risk. But returns with these safe assets are not always great and raises concerns about retail investors’ access to options within financial markets.

Recessions and inflation lead to more unequal outcomes within society. This could be due to the wealthy having more capital so they can buy investments when they are cheaper during a recession. It could also be the fact they have access to more types of investments than the everyday person. This allows the wealthy to invest in more high-performing assets, such as professionally managed private equity and venture capital funds. 

Looking at past investment performance during the dot-com and 2008 financial crisis recessions, both private equity and venture capital performed better than public markets. Private equity was able to achieve excess return over the public markets while venture capital had 16.41 percent average gains. Even in a non-recession market, from 2010 to 2020, venture capital averaged 15.15 percent returns and private equity averaged 13.77 percent. 

This comes as stocks are forecasted to lose value in coming months. The Fed raising interest rates has increased the yield on treasury and corporate bonds on average to 4 and 6 percent respectively. The higher bond yields are nice but most bond returns are still lower than October’s inflation numbers, 7.7 percent. This doesn’t allow for people’s savings to grow in line with inflation.

Private equity and venture capital have done well during past recessions because they are professionally managed and because there is oversight of the portfolio companies. This allows for the investment firms to partner with companies at opportune times. The capital is diversified across different companies in the portfolio. Also, the fact the funds are tied up for 5 to 10 years decreases the volatility of the investments. 

Historically, only institutions and wealthy individuals were able to invest in private equity and venture capital due to the accredited investor rule. This limits direct access for around 90 percent of the United States population from investing. 

In recent years, with the JOBS Act and the SEC loosening regulations, retail investors are able to invest in venture capital and private equity — primarily through equity crowdfunding. 

This is a step in the right direction for the public participation in exclusive investment options, but there are still concerns with using these platforms. These companies don’t have a long track record like the established private equity and venture capital firms.

An established pedigree with highly experienced investors and staff is a major part of good investment performance. It also gives companies looking for money the confidence that their financing partners will make them successful.

Getting established firms to increase the amount of money they raise from everyday people and getting SEC’s support would be a big win for the retail investor. However, getting people on board with considering private equity and venture capital could take time. 

There may be negative perceptions about private equity and venture capital. These concerns include the risk of investing in private companies and having money locked up for five to ten years. Being concerned is logical, but investing in professionally managed funds is less risky than a person trading options or picking highly speculative public stocks. In regards to having money tied up for five to ten years, most people have long-term retirement savings plans that are fairly illiquid; venture capital and private equity should be considered part of that long-term plan. 

There is no perfect solution for the retail investor, but getting people access to alternative solutions like private equity and venture capital could help grow their savings accounts. People should have the option of how they want to invest and firms increasing their crowdfunding practice will give people direct access to a unique wealth-generating tool and further democratize the financial markets.