AI can help firms open private capital to retail investors with transparency
In recent years, regulators across the globe have taken action to broaden private market access to retail investors. For example, the US Securities and Exchange Commission (SEC) relaxed its definition of accredited investors to include knowledge-based qualification in addition to wealth and income-based qualification routes, while the European Commission recently reduced barriers to retail investor participation in private markets through amendments to the European Long-Term Investment Fund rules.2
The regulatory trajectory is also moving in the direction of more disclosures and transparency. The SEC recently passed rules for private fund advisers that, among other things, increase compliance requirements for performance reporting, event-based reporting, and audit reporting.3 Meanwhile, the International Organization of Securities Commissions, a global securities forum, recently pointed to stale valuations as one of the factors that pose a significant risk to the financial system.4 The EU’s European Securities and Markets Authority and the United Kingdom’s Financial Conduct Authority have issued statements on these issues as well.5 As regulators dive deep into the private markets, regulations should continue to evolve. More frequent, AI-powered valuations could help firms stay ahead of compliance and reporting requirements.
While the high returns, resiliency, and diversification benefits of private investments attract investors’ interest in the asset class, some have been deterred by PE’s lack of transparency and low liquidity. Having more frequent valuation may lead to greater transparency, which should make private capital more attractive for new retail investors as well as current private capital investors. The increased transparency could also make secondary transactions more efficient and scalable. Industry regulators will likely favor more frequent valuation as they consider opening the asset class to retail investors.
While some private investment firms value portfolio holdings more frequently, many still perform valuations quarterly. Given the timing of information from portfolio companies, there’s also an inherent lag of weeks to months for the financial data of portfolio companies considered in the valuation models. This time-consuming valuation process is one reason private capital is considered an opaque asset class. Detractors of the PE industry also maintain that lags in the valuation process contribute to systemic risk due to stale pricing.6
Most portfolio companies report their financial data to general partners at least quarterly. For many, structured and unstructured nonfinancial key performance indicators, such as subscription data, shipping data, app usage data, hiring data, and foot traffic data are available on a more frequent basis. Traditional and generative AI tools can ingest and process this nonfinancial data, along with the latest news and industry updates, to modify valuation assumptions and parameters. Incorporating these updates in a timelier manner into the valuation model may help firms arrive at a more holistic valuation based on more frequent data inputs in addition to periodic financial data.
Some private investment firms are already using AI for investment discovery and deal sourcing.7 For these firms, a natural next step could be to pivot these capabilities from pre-deal processes to post-deal processes and incorporate AI into portfolio management, which includes portfolio valuations.
As retail access to private investments becomes more democratized through a combination of AI-enhanced operational changes and more regulatory support, general partners may attract more committed capital from the expanded retail investor segment. Even if general partners are not required to report their valuations more frequently, they may benefit from additional capital earned through having greater transparency and more frequent valuation.
