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October 27, 2014

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For decades, David M. Rubenstein has persuaded big institutions like pension funds and university endowments to invest billions of dollars with his private equity firm, the Carlyle Group, promising them better returns than the general market. But in recent months, he has crisscrossed the country in a campaign to attract a type of investor that has relatively little experience in this industry: individuals.

Carlyle, the Washington-based giant that Mr. Rubenstein co-founded in 1987, is at the forefront of an effort to open the cloistered and risky world of private equity to doctors, lawyers, well-heeled entrepreneurs and others with a brokerage account or, one day, a robust 401(k). The firm is close to establishing a new way to give individual investors direct access to a selection of Carlyle’s private equity funds, according to people briefed on the matter who were not authorized to speak publicly about the private fund-raising campaign in progress.

Not just anyone can jump in. Investors – who must be so-called qualified purchasers, or those who own at least $5 million in investible assets – are required to commit a minimum of $250,000, which is divided evenly across four of Carlyle’s current funds. But the structure sharply lowers the bar on a per-fund basis for direct investment with Carlyle.

The arrangement of private equity funds tends to limit access to them. Wall Street’s private equity firms raise vast pools of capital to buy entire companies. Often, those companies are loaded up with debt in the process, a tactic that adds risks and has generated criticism. The firms typically hold the companies for three to five years, seeking to revamp their finances, before trying to sell them at a profit. Investors in these deals must lock away their capital for as long as a decade, a feature that generally bars all but the wealthiest individuals.

Carlyle’s new vehicle, called Carlyle Private Equity Access 2014, whose existence has not previously been disclosed, is just one of several efforts by the industry to attract checks in the tens of thousands of dollars rather than in the hundreds of millions. In addition to annual fees paid to their wealth manager, investors pay Carlyle 1 to 2 percent of their capital plus 20 percent of any profits, in line with the industry standard.

Gathering more capital allows the already-giant private equity firms to collect more in management fees, a revenue stream prized by Wall Street analysts for its predictability. And Carlyle – along with rival firms like Kohlberg Kravis Roberts and the Blackstone Group – see individuals as a largely untapped source of capital, albeit one that presents a thicket of legal obstacles.

“Everybody’s chasing after money,” said David Fann, the chief executive of TorreyCove Capital Partners, a San Diego firm that advises institutional investors in private equity. “Pension funds are a dying breed,” he added. “The virgin territory is really high net worth and 401(k)’s.”

Private equity firms are responding to a broad shift in how Americans save for retirement. Public pension funds – a traditional source of private equity capital – are growing more slowly than 401(k)’s and other self-directed retirement accounts. The estimated $6.6 trillion in so-called defined-contribution plans looks to private equity titans like an enticing pot of capital, but these retirement plans are usually required by law to invest in liquid assets that can be redeemed for cash quickly.

For now, the largest firms are focusing their efforts on investors’ brokerage accounts. But as they experiment with new fund-raising strategies, the firms are provoking concern among some financial experts who say smaller investors may not be able to understand the substantial risks.

“The question is, Is it a game for amateurs?” said Josh Lerner, a professor of investment banking and entrepreneurship at Harvard Business School. “The historical record has not really been an inspiring one.”

Already, big private equity firms can draw capital from the multimillionaires who have accounts at Wall Street brokerage firms like Goldman Sachs and Morgan Stanley. In the 12 months through the end of September, Blackstone raised $10 billion through such “feeder funds” run by brokers and through its other retail offerings, out of a total of $54.8 billion coming in the door. That is a sharp increase from 2011, when Blackstone raised $2.7 billion through these channels out of $49.5 billion.

Morgan Stanley, for example, was recently gathering capital from wealthy clients for a new Blackstone energy fund that is expected to exceed its $4 billion target when it finishes raising capital this year. It took the bank a single day to raise its entire $500 million feeder fund, which was about four times oversubscribed, people briefed on the matter said.

The biggest firms have the infrastructure and staff to gather many small checks, making them better equipped than their smaller cousins to lead this market. Across the entire industry, individuals provided 11 percent of the capital raised from 2011 to 2013, compared with 8 percent from 2007 to 2009, according to the data provider Preqin.

Investment advisers with experience working with smaller investors are in demand by private equity heavyweights. Blackstone hired Deann Morgan last year from Merrill Lynch to develop wealth management products. Kohlberg Kravis Roberts recently hired Blake Shorthouse to gather capital from wealthy families in Europe. And in March, Carlyle hired Jeffrey C. Holland, an executive at a real estate investing firm, as the head of its private client group, a newly created role.

To pitch the Private Equity Access vehicle, Mr. Rubenstein of Carlyle has spoken to clients of registered investment advisers at an event in Los Angeles and at Carlyle’s offices in Washington, among other events, some of the people briefed on the matter said. Carlyle, which has been meeting with independent wealth advisers including Joel Isaacson & Company, aims to raise $200 million through the vehicle and introduce a similar one next year.

Traditional feeder funds can also allow investors to commit as little as $250,000, but the new Carlyle product is intended to provide a more diversified investment, including private equity funds focused on Japan, Asia and Europe, as well as an international energy fund.

A spokesman for Carlyle, Christopher Ullman, declined to comment on the new investment vehicle.

Other firms, acting as middlemen, are allowing the private equity giants to attract a lower stratum of wealth. One firm, the Central Park Group, gives investors indirect access to Carlyle funds. It caters to so-called accredited investors, who have at least $1 million in assets not including their primary home. Because it is an intermediary, the firm charges a fee as high as 1.8 percent and an additional 0.55 percent for expenses, on top of the 1.3 percent of assets charged by the Carlyle funds in which it invests, according to marketing materials and a person briefed on the matter. Still, it has raised more than $500 million since its debut last year, this person said.

Some entrepreneurs see an opportunity in this market. This month, Dan Vene, a former executive at the hedge fund Fir Tree Partners, unveiled a new website he co-founded, iCapital Network, which allows wealthy individuals to invest directly in lesser-known private equity funds. Mr. Vene said that investors – those who meet the definition of qualified purchasers – pay annual fees below 1 percent.

“Most of the industry is using very clever marketing tactics to charge very high fees,” Mr. Vene said. “And they’re not even giving you access to the real flagship fund you think you might be investing in.”

Others are concerned that giant private equity firms, in their rush to gather capital, may be compromising their mission to generate profits for their investors.

“There’s a fair amount of concern that the larger funds are less performance-driven because they’re making so much money off the asset management fees,” said Michael Sonnenfeldt, the founder of TIGER 21, a network for high-net-worth investors. “What you find is the large funds are capital aggregators. They’re making profits regardless.”