Chidem Kurdas
Our retirement investing is still a new world. Our grandparents received defined benefit pensions, which were paid out of big pools allocated in large chunks to diverse categories of assets. The allocation was decided by professionals.
Our parents were the transitional generation.
Today, most of us don’t get defined benefit pensions; we have 401(k) and similar accounts, which we typically invest in stock and bond mutual funds. These will take small monthly payments and redeem daily, in sharp contrast to some of the investments made by defined benefit pensions. We choose from a limited menu.
Asset categories like private equity and natural resources – which traditionally require large chunks of money locked up for years – are absent from our accounts. As a result, compared to defined benefit pools, our individual accounts are much less diverse. Given this situation, creating products suitable for individual retirement investing is the new Holy Grail of money management.
This is relatively easy for some hedge fund strategies but especially difficult for private equity. Hence the complexity underlying the product offered by California-based Altegris. The fund is to invest most of its assets in buy-out funds managed by long-time private equity specialist KKR or directly in KKR portfolio companies.
When Altegris KKR Private Equity was registered in May, it was widely reported that the vehicle would target smaller investors with a minimum of only $10,000. But that turns out to be inaccurate—in fact the up-to 15 million share offering requires an initial minimum investment of $25,000. Additional investments after that require minimum $10,000.
Still, the amounts are modest enough for individuals who own $1 million net assets, as necessary to be an accredited investor, a condition for buying the shares.
We’re talking about a closed-end fund with unlisted shares, so there won’t be an established market for the shares. The only sure way for an investor to redeem is to wait for Altegris to buy back shares but that will not happen for two full years. In its third year, the fund might start offering buy-backs every quarter but it will not buy more than 5% of the shares.
The tricky part is what the offering prospectus calls the commitment strategy. This is the dilemma that the more cash the fund keeps, the greater the drag on return, but if all assets were committed to private equity, the fund will be extremely illiquid. In the latter situation it may not be able to take advantage of attractive new opportunities; neither will it be able to buy back its own shares from customers who want to redeem.
Illiquidity is built into private equity—buy-out deals take time, companies are held for years and selling them takes more time. As the Altegris KKR prospectus acknowledges, private equity investments “are generally subject to lengthy lock-up periods during which the fund will not be able to dispose of such investments except through secondary transactions with third parties…” Such transactions may not be possible at a given time or may be doable only at a huge loss.
Then again, let’s think about what investors really need. Why do long-term retirement accounts need liquidity? If you are in the middle of your career you may not retire for 20 years. For any individual not close to retirement, the daily redemption offered by mutual funds is a pure loss—you won’t need the money for a long time and you could obtain a higher return from illiquid investments.
The extremely limited menus offered by many 401(k) programs harm the supposed beneficiaries from this perspective as well as for the general lack of diversification. Recent studies show that private equity on the whole does have a higher return than the stock market. Indeed, that’s why defined benefit pensions invested in it.
Regulations require daily liquidity for mutual funds but this is useless in a retirement account that’s not going to be tapped for decades. The regulatory state itself creates the problem here, as in other areas.
So the Altegris KKR fund is a useful product but it is unconventional in the context of individual investing. Whether it will succeed in getting sufficient interest remains an open question.
