The Benefits of Being a Qualified Purchaser

Summary

Qualified purchasers gain access to different investment opportunities and enhanced portfolio diversification.

Person learning about opportunities for qualified purchasers

The U.S. Securities and Exchange Commission (SEC) outlines the requirements for becoming a qualified purchaser under the Investment Company Act of 1940. The process doesn’t involve any complex regulatory filings or licenses. Instead, becoming a qualified purchaser is a self-certification process where an individual, trust, or institutional investor provides documentation showing a level of financial resources and sophistication that’s deemed adequate for investing in higher-risk private investments. So, what exactly does the designation allow you to do and what are the benefits that come with being a qualified purchaser?

Expanding investment horizons

Because a qualified purchaser is an individual or entity that meets specific financial criteria, they often have access to higher-risk private investment opportunities that are considered off-limits to investors in publicly traded securities. Of course, the flip side of higher risk is typically the potential for higher reward and opportunities to enhance portfolio returns.

Private investments can also add an important element of diversification by investing in areas that are less correlated with publicly traded stocks and bonds. In addition, private asset classes have historically produced better returns after fees than U.S. equities and high-yield bonds (from 2000-2020).1

Types of private market investments

The universe of privately held assets is estimated to be more than five times larger than public markets.2

 One example of a private market investment is venture capital (VC), an area of private investing that often relies on qualified purchasers to invest in their projects due to the higher-risk, higher-reward nature of the industry. Examples include startups, growth equity, late-stage investments, buyouts, secondary investments, restructurings, spin-offs, special purpose acquisition companies (SPACs), and ESG initiatives.

Different types of non-publicly traded funds are also available to qualified purchasers:

  • Private equity funds often invest directly in private companies, offering diversified pooled investments in private markets.
  • Private credit – investments are a form of “real assets,” which contain physical assets we see in everyday life like bridges, roads, highways, sewage systems, etc.
  • Real estate funds invest in development projects, commercial properties, and real estate investment trusts (REITs).
  • Infrastructure – investors combine or pool their capital and enable the manager of the fund to make investments in loans to various private companies.

Details on private investments image

Risks and other opportunities

It’s important to note that investing in private investments comes with its own set of risks and considerations. Investors should carefully consider the following before they invest:

Lack of liquidity: Private investments are, by definition, less liquid than traditional assets. This means that selling them quickly, if needed, is difficult at best. Advisors should always therefore ensure clients have suitable liquidity outside any allocation to private investments.

Higher costs: Private investments often come with higher fees and expenses compared to traditional investments. Such fees typically include fund management fees, performance fees, and operational costs.

Long-term holding periods: Investors allocating to private investments should expect to hold those investments for approximately 10 – 12 years. This is significantly longer than the typical holding period for most public investments. Further, most private investment funds slowly return capital to investors over a period of years as managers slowly sell off the funds’ portfolio companies. Said differently, with private investments, investors should not expect to see a return of their capital all at once.

Lack of information: Compared to registered investment vehicles like mutual funds and ETFs, publicly available information on private investment funds is relatively limited.

Complexity and due diligence: Private investments can be complex and require a deeper understanding of the underlying assets and strategies. Thorough due diligence by an investment team with deep experience in private assets is critical.

Regulatory and tax considerations: Some private investments are subject to regulatory restrictions and may have specific legal requirements that need to be considered prior to investing. For example, some fund structures are open only to qualified purchasers with more than $5 million in invested assets; others are open to individual Accredited Investors with documented incomes of at least $200,000 in AGI or $1 million in net worth (excluding primary residence). Additionally, tax accounting for private investments is almost always more complicated than it is for public investments. Investors in private investments require more sophisticated tax expertise; having a CPA with knowledge of such matters is a must.

Higher risk: While private investments can offer attractive returns, they also come with greater risks, including the potential for loss of capital. It’s important to carefully assess your risk tolerance, liquidity needs, and financial planning objectives before investing in private assets.

Investor experience: K1’s are distributed for many private market investments instead of 1099’s and their timing can be irregular – you will most likely need to file an extension with the IRS. After you commit capital to a private market investment, it can take years for that capital to be called (used by underlying manager for investments), can be called at any time, and you must earmark those committed funds for future investments.

Takeaway

A qualified purchaser is a sophisticated investor with the financial resources to take on the risk associated with some investments in the private markets. With higher risk comes the possibility of higher returns and more diversified portfolios. If you are interested in learning more about the benefits of being a qualified purchaser and private markets, contact us.

1 Burgiss, Yahoo! Finance, FRED Economic Data, as of February 2024, for January 1, 2000 to January 1, 2020.

2 McKinsey Global Institute, “The Rise and Rise of the Global Balance Sheet,” 2021.

Mercer Advisors Inc. is a parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.

All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.

This information is provided for informational purposes only and is not intended as, a recommendation, or as an offer to sell, a solicitation of an offer to purchase or a recommendation of any interest in any fund or security. Any such offer can be made only via the relevant access fund’s formal offering documents. Investing in private funds is speculative and will entail substantial risks. Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance and results of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark.

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