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When financiers gathered at the Milken conference last month, a chart was passed around that should make policymakers, voters and investors rethink the nature of modern capitalism.
The chart showed that between 2000 and 2018 the number of private equity-backed companies in America rose from less than 2,000 to nearly 8,000. Publicly listed companies in this period, by contrast, fell from 7,000 to about 4,000.
To be fair, the aggregate value of those private equity-backed companies is still “only” $5tn — far less than the combined $30tn value of US public companies. But that $5tn number is striking, not least because it excludes a vast swath of other privately held groups.
What is doubly notable is that the explosion of private activity is not restricted to equities. In the past decade, private debt markets have expanded at a striking clip, totalling more than $600bn today. Private infrastructure and real estate investment is also expanding.
Indeed, Willis Towers Watson calculated a couple of years ago that global asset owners have now placed about 14 per cent of their assets in private markets (mostly private equity and real estate), up from virtually nothing a couple of decades ago. They predict this will rise to 20 per cent in 10 years.
Some observers, such as Henry Fernandez, chief executive of MSCI, think it could be considerably higher. MSCI is so convinced that this drift toward private finance is here to stay that it is quietly developing indices and portfolio tools to help investors track these private securities and assets. The group thinks that this could be one of the hottest new frontiers of finance in the coming years. That is notable given that MSCI has forged a name for itself as a champion for public markets, expanding its equity and bond indices around the world.
“Historically investments were about private markets. In the last century that changed and institutional money went into public markets,” Mr Fernandez says. “Maybe we should ask if . . . we are reverting more to the historical norm?”
If so, that would overturn many of the current presumptions about modern finance. In the 20th century, it was often assumed that public markets were the epitome of financial capitalism; indeed, the idea was so deeply ingrained that policymakers and financiers tended to assume that financial evolution went in one direction: from private to public.
But today the trend towards private finance is being driven by “pull” and “push” factors. On the one hand, private equity, real estate and debt investments have often offered better returns than public equity in the past decade. And while these sectors used to be run like cottage industries, they are maturing — or at least aping some elements of public markets with slightly better reporting. Hence the desire of MSCI and others to jump in.
At the same time, the raison d'être for public markets is faltering. They used to be seen as a more democratic and inclusive form of capitalism (because securities owners had a voice), offering more transparency (since there was more reporting) and liquidity (with more trading). It was also thought that if corporate managers faced the wisdom of (shareholder) crowds, companies would be better run.
But the spread of dual class listings, which give a few owners disproportionate power, is undermining the idea of shareholder democracy. Meanwhile, critics argue that the rise of activist investors and quarterly corporate reporting has fostered a more short-term corporate culture. Liquidity in public equity and bond markets has sharply declined since 2008, while financing for private deals has grown.
Maybe this is just a fad, driven by cheap money. It is unclear how the recent boom in private finance will perform if (or when) the credit cycle turns. “The returns on private equity do not look sustainable — they are already falling,” points out William Lee, chief economist at Milken. This is not reassuring, particularly since no amount of hype about new “investor friendly” tools and indices can change the fact that private finance is private — and thus prone to be opaque and illiquid.
There are two key points that investors need to ponder. Firstly, the tale should act as an urgent wake-up call for policymakers to begin addressing the all-too-visible shortcomings of public markets — particularly if they believe, as I do, that public markets remain the best way to create participatory and democratic capitalism. Second, we cannot assume that history follows a straight line. In finance — as in politics — the pendulum can sometimes swing in some surprising ways; and not always in a manner that represents “progress”.
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