Wed, Feb 19, 2025

Unlocking Retail Access to Private Funds: Navigating Complex Regulations

/en/our-team/colleen-corwell Colleen Corwell | Financial Services Compliance and Regulation | Kroll

Colleen Corwell

David Larsen

The retailization of private fund assets via registered investment companies (RICs) is transforming the investment landscape, offering retail investors access to opportunities once reserved for institutions. This shift promises diversification and higher returns but introduces complex regulatory challenges for fund managers. Alternative investment managers are commonly employing interval and tender offer fund structures to access the growing retail marketplace. According to the XA Investments research team, combined interval fund/tender offer fund market assets are forecasted to reach $220 billion and 275-plus funds by year-end in 2025. In 2025, private credit is expected to continue dominating capital raising and new fund formations due to strong client demand for yield. The private equity and hedge fund categories of the interval/tender offer fund market are expected to follow close behind private credit in terms of growth and investor adoption next year.

Historical Context and Drivers: The Shift of Endowments and Pension Funds from Public Markets to Private Fund Assets

In recent decades, endowments and pension funds have shifted their asset allocation from public markets to include private investments. This trend is driven by the pursuit of higher returns and diversification benefits that private markets offer. By 2023, U.S. state pension funds had allocated 40% of their assets to alternatives, up from 30% in 2018. The largest gains were in private equity, which grew from 9% to nearly 15% of total assets.¹ 2024 could be deemed the year of private credit, with significant expansion of investments in credit-related funds. Historically, several prominent endowments and pension funds have embraced private markets to enhance returns and diversify their portfolios. Yale, Harvard and Stanford universities have significantly allocated to private equity and venture capital, while CalPERS, CPP Investments and the Teacher Retirement System of Texas have ramped up investments in private equity, infrastructure and real estate.² These strategic shifts reflect a broader trend among institutional investors seeking higher returns and unique opportunities in private markets.

One of the pioneers of this shift was Yale University’s endowment, managed by David Swensen. In the mid-1980s, Yale’s portfolio was heavily weighted toward U.S. equities (65%) and bonds (15%), with no allocation to private equity. By 2020, Yale had dramatically reduced its public equity exposure to 14% and allocated 38% of its portfolio to private equity and venture capital.^{3 5}

Several factors have driven this shift:

Higher Returns: Private equity, private credit and venture capital have historically provided higher returns compared to public markets. For instance, top quartile private equity funds have consistently outperformed public equities over the long term.⁶ According to a study by the National Bureau of Economic Research, every dollar invested in private equity yielded a 20% higher return than every dollar invested in the S&P 500.⁷ Additionally, private investment funds have earned an average incremental return of over 6% relative to traditional public equity markets over the past 20 years.⁹
Diversification: Private assets offer diversification benefits, reducing overall portfolio volatility. By spreading investments across various asset classes, such as private equity, real estate and private credit, investors can achieve a more stable portfolio with lower correlation to public markets.¹⁰
Access to Unique Opportunities: Private markets provide access to investments not available in public markets, such as early-stage companies, including technology startups, and real estate projects. These unique opportunities allow investors to engage with high-growth companies and innovative business models that are not yet widely adopted. Additionally, private markets offer investments in rare collectibles and other alternative assets that are typically inaccessible through public markets.

Decline in Public Companies

The number of publicly traded U.S. companies has halved from 8,000 in the mid-1990s to around 4,000 today.¹¹ Given the decline in the number of public companies, achieving true diversification without an allocation to private markets is difficult, and it is generally believed that retail investors remain under-allocated to alternative asset classes. This decline is attributed to several factors:

Increased Private Financing: More companies are opting for private funding instead of going public. For example, private credit assets under management in the U.S. surged from $500 bn in 2010 to nearly $1.7 trillion by 2023.¹³ Additionally, global private equity fundraising reached a record of almost $1.2 trillion in 2022, reflecting a nearly 20% year-over-year increase.¹⁴ This growth underscores the increasing reliance on private financing as companies seek alternatives to public markets.
Regulatory Burdens: The costs and regulatory requirements associated with being a public company have increased, making it less attractive for many firms.
Shift to Intangible Assets: Companies focused on intangible assets, such as software and intellectual property, often prefer to stay private to avoid disclosing sensitive information.

Today’s Trends: The Retailization of Private Funds

Over the past few decades, endowments and pension funds have increasingly shifted their investment strategies from public markets to private funds, driven by the pursuit of higher returns and diversification benefits. This trend is further supported by the significant decline in the number of publicly traded companies, as more firms opt for private financing due to regulatory burdens and the nature of intangible assets. As these trends continue, there has been an increasing demand for public access to private markets.¹⁵ This shift toward private markets is expected to continue as both institutional and retail investors seek diversified opportunities and enhanced returns in an evolving financial landscape. “We see no slowing of the trend toward the democratization of alternative strategies, and closed-end funds (CEFs) have developed as the preferred fund wrapper for getting private markets investments to individual investors,” says Bill Bielefeld, a partner at Dechert LLP.

The trend of firms launching RICs with private assets has been growing. Listed and non-listed CEFs are continuing their rapid growth. As of the end of December 2024, there were 257 CEFs (interval funds and tender funds), with total assets of $208 bn.¹⁶ Year-over-year net asset growth is 29.0% for interval funds and 39.6% for tender offer funds. While the number of active interval and tender offer funds has increased, 51 CEFs have filed registration statements with the SEC and are still pending effectiveness. This growth is driven by the increasing popularity of private credit and real estate strategies within CEFs.

The CEF structure provides retail investors with access to private fund assets, democratizing investment opportunities traditionally reserved for institutional investors. Similar vehicles are being seen in Luxembourg and the United Kingdom through long-term asset funds.

The surge of interest in the retailization of private funds is driven by several key factors:

Better Understanding of Risks and Improved Controls: As the risks associated with private funds become better understood, more robust controls and regulatory frameworks have been put in place. This has increased confidence among retail investors, making private funds more accessible to a broader audience.
Technological Advancements: The rise of technology has enabled daily monitoring and estimation of net asset values (NAVs) for private funds. This technological progress has made it easier for retail investors to track their investments and make informed decisions, thereby increasing their participation in private funds.
Retail Interest in Private Fund Returns: Retail investors are increasingly seeking the higher returns that private funds can offer. This growing interest is fueled by the desire for diversification and the potential for higher yields compared to traditional public market investments.

Launching a RIC with Illiquid Assets

Launching a RIC with illiquid assets requires selecting the appropriate fund type and structure to ensure compliance and meet investor needs. For example, interval funds, tender offer funds and mutual funds offer different levels of liquidity and investment strategies, making this decision crucial for effective management. RICs must comply with the regulatory requirements set forth by the Investment Company Act of 1940 (“1940 Act”), ensuring transparency, governance and investor protection. “Launching a RIC such as an interval fund is a lengthy process (six-plus months) and requires a committed working group. Most private fund sponsors do not have experience with interval fund structuring, so consulting outside experts is critical to saving time and money,” says Kimberly Flynn, President of XA Investments.

“There are a number of unique legal, compliance, distribution and marketing hurdles, which are quite different for these types of funds, that private fund sponsors will need to grapple with,” says Bielefeld.

Below is a summary of the types of RICs that can hold illiquid assets:

Interval Funds: These CEFs allow investors to purchase shares at any time but only permit redemptions at specified intervals, such as quarterly or annually. They often invest in illiquid assets like private equity, private credit and real estate.
CEFs: These funds have a fixed number of shares and are traded on stock exchanges. They can invest in a variety of illiquid assets, including private equity, real estate and other alternative investments.
Tender Offer Funds: Similar to interval funds, these CEFs allow investors to redeem shares at specific intervals, but the repurchase offers are made at the discretion of the fund’s management.
Mutual Funds: While traditionally focused on liquid public securities, some mutual funds include allocations to illiquid assets to enhance returns and diversification. However, they are typically limited to holding no more than 15% of their total assets in illiquid investments.
Exchange-traded Funds (ETFs): Although primarily investing in liquid assets, certain specialized or thematic ETFs may include illiquid assets in their portfolios.
Real Estate Investment Trusts: These companies own or finance income-producing real estate and can include private real estate investments in their portfolios.

Numerous large asset managers have successfully integrated private fund assets into RICs. And numerous other managers are contemplating launching RICs.

A Compliance Overview

Launching a RIC with private fund assets requires ensuring sufficient liquidity for redemptions; robust valuation policies; compliance with the 1940 Act; independent board oversight; a designated chief compliance officer (CCO) of the fund; and adherence to marketing, distribution and reporting rules.

Following are highlights of some of the main requirements:

Liquidity
- Sufficient Liquid Assets: RICs must ensure they have enough liquid assets to meet periodic redemption requests. This involves maintaining a balance between liquid and illiquid assets to manage cash flow effectively.
- Liquidity Risk Management Programs: Under SEC Rule 22e-4, RICs are required to implement liquidity risk management programs to assess and manage the liquidity of their portfolios.
Redemption Requests
- Redemption Policies: Interval funds, for example, must establish clear policies for redemption intervals (e.g., quarterly or annually) and ensure these policies are communicated to investors.
- Redemption Limits: Funds may set limits on the percentage of shares that can be redeemed during each interval to manage liquidity and protect remaining investors.
Board Oversight
- Independent Board Members: The 1940 Act mandates that a majority of the board of directors be independent of the investment adviser to ensure unbiased oversight.
- Valuation Oversight: The board or a valuation designee must actively oversee the valuation processes, including approving and monitoring pricing services and valuation service providers. Boards must ensure they are compliant with rule 2a-5 with respect to determining fair value.
CCO
- Designation and Responsibilities: The RIC must designate a CCO responsible for administering the compliance policies and procedures. The CCO must report directly to the board of directors.
- Annual Reviews: The CCO is required to conduct annual reviews of the compliance program per Rule 38a-1 to ensure its effectiveness and address any deficiencies.

Additional Compliance Requirements Under Rule 38a-1
- Written Policies and Procedures: RICs must adopt and implement written policies and procedures reasonably designed to prevent violations of federal securities laws.
- Annual Compliance Review: The CCO must conduct an annual review of the adequacy of the policies and procedures and the effectiveness of their implementation.
- Recordkeeping: RICs must maintain detailed records of compliance activities, including documentation of the annual reviews and any actions taken to address compliance issues.
Valuation
- Periodic Assessment of Valuation Risks: Compliance with SEC Rule 2a-5, the “Good Faith Determinations of Fair Value” rule, mandates periodic assessment of valuation risks.
- Appropriate Valuation Methodologies: Funds must use appropriate methodologies to determine the fair value of illiquid assets.
- Oversight of Pricing Services: The board or a valuation designee must oversee pricing services to ensure accuracy and reliability.
- Testing Accuracy of Valuation Methods: Rule 2a-5 requires funds to test the accuracy of their valuation methods and maintain detailed records.
- Frequency of Striking NAV: Deciding the frequency of striking a NAV is important; interval funds typically strike a NAV daily or at regular intervals for transparency. More frequent and more timely valuation determination requires adjustment to existing valuation policies and procedures and often requires third-party valuation specialist involvement to satisfy RIC distribution facilitators.

Compliance controls under Rule 2a-5 include processes for approving, monitoring and evaluating pricing services, with active oversight by the board or valuation designee. Enforcement actions often focus on failures to manage valuation risks or inaccuracies in fair value determinations. For instance, the SEC took action against a registered investment adviser for failing to implement and oversee valuation policies, resulting in a $300,000 civil penalty.¹⁷ The valuation of illiquid assets was also highlighted in the SEC’s most recent examination priorities.¹⁸ “As these products are structured to offer the ability to purchase on a daily basis, the valuation process becomes a key area for advisers to focus on and make sure that there is a robust process for daily valuations on assets that the adviser may not have valued daily in the past,” says Bielefeld.

The regulatory and operational considerations are essential for ensuring compliance and protecting investors as private fund managers transition to offering retail investment products.

Advisers Act vs. 1940 Act

Private Funds—Investment Advisers Act of 1940

Scope: It requires SEC registration for advisers managing over $100 million in assets or advising a RIC. Advisers with less than $100 mn register with state authorities
Fiduciary Duty: It imposes a fiduciary duty to act in clients’ best interests, which includes providing advice that is in the best interest of the client, fully disclosing all material facts and avoiding conflicts of interest.
Disclosure Requirements: It requires detailed disclosures about business practices, fees, conflicts of interest and disciplinary history through Form ADV, which must be filed with the SEC and updated regularly.

RICs—Investment Company Act of 1940

Scope: It regulates RICs, including mutual funds, CEFs and ETFs. These companies must register with the SEC and comply with specific 1940 Act regulatory requirements.
Structural Requirements: It imposes strict requirements on the structure and operations of investment companies, including limits on leverage, requirements for independent directors and restrictions on transactions with affiliates. The 1940 Act also mandates that a majority of the board of directors be independent of the investment adviser.
Disclosure and Reporting: It requires regular disclosures about the financial condition, investment policies and performance of the fund. These disclosures are designed to provide transparency and protect investors by ensuring they have access to essential information about the fund’s operations and investments.

Examples of SEC RIC Reporting:

Annual and Semiannual Shareholder Reports (Forms N-CSR and N-CSRS): detailed fund performance and financial statements
Form N-PORT: monthly portfolio holdings
Form N-CEN: annual census-type information
Form N-1A: registration for mutual funds
Form N-2: registration for CEFs
Form N-PX: annual proxy voting records
Form N-LIQUID: reporting significant liquidity events

Key Considerations from the SEC’s Recent RIC Risk Alert

The SEC’s recent Risk Alert for RICs emphasizes the importance of effective compliance programs, accurate disclosure practices, robust board governance, proper valuation and pricing of illiquid assets, and management of conflicts of interest to protect investors.¹⁹

The SEC’s recent Risk Alert for RICs highlights several focus areas:

Compliance Programs: effective written policies to prevent securities law violations
Disclosure Practices: accurate and clear disclosures aligned with practices
Board Governance: effective oversight with necessary information
Valuation and Pricing: robust practices for funds with illiquid assets
Conflicts of Interest: identification and management of conflicts to act in investors’ best interests

Conclusion

The retailization of private fund assets through RICs potentially offers retail investors access to high-return, diversified strategies. This shift is driven by increased allocations from endowments and pension funds, fewer publicly traded companies, and the popularity of private credit and real estate.

However, this transformation also introduces a complex regulatory landscape that fund managers must navigate. Key considerations include ensuring compliance with SEC regulations like Rule 2a-5 for the fair valuation of illiquid assets and adhering to the governance and disclosure requirements of the 1940 Act. The SEC’s recent Risk Alert underscores the importance of robust compliance programs, accurate disclosures, effective board governance and the management of conflicts of interest.

By understanding these regulatory requirements and implementing best practices, fund managers can successfully launch and manage interval funds that provide retail investors with access to private fund assets, thereby democratizing investment opportunities and potentially enhancing portfolio returns.

Sources
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² Thorne, J. (2021, November 3). Meet the managers and holdings behind top university endowments. Pitchbook. https://pitchbook.com/news/articles/managers-holdings-top-university-endowments-private-markets; Hagedorn, D. (2023, February 17). Private equity, venture capital outpace public equities in 2022 higher education endowments. Chief Investment Officer. https://www.ai-cio.com/news/private-equity-venture-capital-outpace-public-equities-in-2022-higher-education-endowments; Teacher Retirement System of Texas. (n.d.). Portfolio allocation. https://www.trs.texas.gov/Pages/investment_team_external_private_markets.aspx; Rosenberg, J. S. (2021, October 29). Harvard endowment increases $11.3 billion, and university operates at a surplus. Harvard Magazine. https://www.harvardmagazine.com/2021/10/harvard-endowment-surges-11-3-billion-university-surplus
³ Infinger, G. (2024, June 25). Sizing private equity allocations — verdad. Verdad. https://verdadcap.com/archive/sizing-pe-allocations
⁵ Capital Square. (n.d.). The Yale endowment model & the growth potential of illiquid alternative assets. https://capitalsq.com/expertise/yale-endowment-model-alternative-assets
⁶ Fenancio, G. (2024, November 17). Historical performance of private equity. Private Equity List. https://blog.privateequitylist.com/historical-performance-of-private-equity; Swedroe, L. (2024, March 19). The long-term performance of private equity. Wealth Management. https://www.wealthmanagement.com/alternative-investments/long-term-performance-private-equity
⁷ Harris, R. S., Jenkinson, T., Kaplan, S. N., & National Bureau of Economic Research. (2012). Private Equity Performance: What Do We Know? NBER Working Paper Series, 17874. https://www.nber.org/system/files/working_papers/w17874/w17874.pdf
⁹ J.P.Morgan. (n.d.). An alternative source of opportunity and return potential. https://privatebank.jpmorgan.com/content/dam/jpm-wm-aem/documents/private-investments-2020.pdf
¹⁰ Partners Group. (n.d.). Portfolio diversification: No one-size-fits-all approach. https://www.partnersgroup.com/en/~/media/Files/P/Partnersgroup/Universal/perspectives-document/20220531-partners-group-research-portfolio-diversification.pdf
¹¹ Goodkind, N. (2023, June 9). America has lost half its public companies since the 1990s. Here’s why. Retrieved February 9, 2025, from https://www.cnn.com/2023/06/09/investing/premarket-stocks-trading/index.html
¹³ Cai, F., & Haque, S. (2024, February 23). Private credit: Characteristics and risks. Board of Governors of the Federal Reserve System. https://www.federalreserve.gov/econres/notes/feds-notes/private-credit-characteristics-and-risks-20240223.html
¹⁴ McKinsey Global Private Markets Review 2022. (2022). Private markets rally to new heights. https://www.mckinsey.com/~/media/mckinsey/industries/private%20equity%20and%20principal%20investors/our%20insights/mckinseys%20private%20markets%20annual%20review/2022/mckinseys-private-markets-annual-review-private-markets-rally-to-new-heights-vf.pdf
¹⁵ State Street. (2024, April 29). State Street private markets survey finds macro challenges not dampening demand; public to private shift set to grow further. https://investors.statestreet.com/investor-news-events/press-releases/news-details/2024/State-Street-Private-Markets-Survey-Finds-Macro-Challenges-Not-Dampening-Demand-Public-To-Private-Shift-Set-To-Grow-Further/default.aspx
¹⁶ XA Investments. (2024, November 5). Non-listed CEF market (interval and tender offer funds) monthly update. https://api-funds.paralel.com/download_resource/?id=6304&ticker=XAI
¹⁷ U.S. Securities and Exchange Commission. (2022, June 3). SEC charges adviser with compliance violations relating to valuation of mutual fund assets. https://www.sec.gov/enforce/ia-6040-s
¹⁸ U.S. Securities and Exchange Commission. (2024). Fiscal year 2025 examination priorities: Division of examinations. https://www.sec.gov/files/2025-exam-priorities.pdf
¹⁹ U.S. Securities and Exchange Commission. (2024, November 4). Registered investment companies: Review of certain core focus areas and associated documents requested. https://www.sec.gov/files/risk-alert-registered-investment-companies.pdf

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