Duncan Lamont, Head of Strategic Research at Schroders, discusses the potential benefits of investing in private assets.
Before it listed on the stock market in 2004, Google had raised a mere $25 million privately. Today, there are companies raising more than 500 times that amount. Would Google (now Alphabet) list at such an early stage of its growth today? Not a chance.
The emergence and growth of private markets have played a pivotal role in reshaping how companies finance themselves. Investment strategies had to change too, but also how investors access the market. Previously, only institutional investors had the keys to this opportunity but access is broadening, with increased participation from high-net-worth individuals and retail investors.
What’s changed?
In the US, over 300 companies a year, on average, joined the stock market between 1980 and 1999. Since, there have been only 127 a year. Alongside a lack of new entrants, M&A-driven de-listings have consistently reduced the stock of existing companies on the public market. The number of US listed companies has dwindled by nearly half since the 1996 peak. And this is the much-vaunted US market. Others are mostly worse.
This is down to a combination of the increased scale of the private equity industry (which can now write bigger cheques) and an increase in the perceived cost and hassle of a stock market listing. Companies are staying private for longer and more of the returns are being captured by private equity investors. Investors who don’t incorporate private assets in their portfolio risk missing out.
What is the appeal of private assets?
1. Provide higher returns/income.
Private equity buyouts have outperformed US large and small caps by a significant margin (net of fees) over the long run. And private debt offers a yield pickup over corporate bonds. The secured nature of asset-based finance also helps to provide a more stable return profile than corporate bonds.
2. Provide access to a broader range of exposures, industries, or outcomes.
The shift to private market financing means that investors can only access the full opportunity set by allocating to private markets. The sector and regional split of many public markets is also not representative of the characteristics of the asset class as a whole. This can skew outcomes. Infrastructure debt is a good example. The public infrastructure bond market is dominated by utilities and US issuers, whereas the infrastructure debt market is far more diverse by sector and region.
3. Reduce risk (volatility and/or risk of loss)
Returns from many private assets are less volatile than public markets, which appeals to many investors. However, in some cases, this is down to valuation methodologies, which can smooth reported price variability.
4. Add diversification benefits by introducing differentiated drivers of returns
Given their differing underlying exposures and return drivers, private assets offer diversification benefits compared to public markets. These vary by asset class and market. Given issues with valuation approaches, a better way to consider the relationship between public and private returns is to look through to the underlying exposures and focus on differentiated drivers of returns, not statistical estimates of correlation.
5. Provide more direct exposure to impact investing
In recent years, an increasing number of investors have become focussed on the impact they have with their investments. Private markets offer distinct advantages for creating and measuring impact in a more precise manner than is possible in public markets.
Practical considerations
Increased interest in private assets has led to large amounts of capital being raised in the past decade. “Dry powder”, money raised but not yet invested, has hit record highs. High fundraising runs the risk of too much money chasing the same deals, higher prices being paid, and lower future returns. Large buyouts and direct lending are two of the hottest spots on this front.
Better opportunities can be found by seeking out less crowded markets and by using the credibility and reputation of an investment manager to gain access to deals that others would not see. Deal access has become one of the most important edges that a successful investor can lay claim to.
Private markets offer a rich variety of investment options which can diversify and enhance risk and return for investors. With their growing clout, more and more financing is taking place privately. Investors focussed solely on public markets risk missing out. There is no shortage of attractive opportunities but, with increased interest has come increased competition. Investors should seek out less crowded markets to benefit from the return and risk enhancement that private assets can offer.
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