Updated: Feb 8
The Economist February 1st, 2020 pp61-63 Finance and Economics. Asset Management “Privacy and its limits”. “When an idea is universally held in finance it often pays to be cautious. Right now almost everyone believes that private markets are better than public ones.”
Investment dollars are increasingly flowing into private equity funds rising from ~ $1 trillion in 2004 to more than $6.5 trillion in June 2019. Not available to small investors, the largest pension funds and endowments hold most of these shares. Some of these funds are heavily invested with Yale Endowment having ~70% of their investments in private equity followed by some notable others including CalSTRS (~30%), NY State & Local Retirement System (~27%), CalPERS (~25%) and others. The top four private equity groups are benefiting with Blackstone at ~$0.5 trillion followed by Apollo (~$0.3 trillion), Carlyle (~$0.2 trillion) and KKR (~$0.2 trillion).
The opposite of public index funds-which consists of shares of publically listed firms-are widely held-heavily traded-are passively managed and have low fees, private equity funds-consists of shares or private debt of unlisted companies-are actively managed and have high fees. The arguments for private equity include; a longer investment window allows companies within these funds to be more strategic, overhead costs are lower as the funds are managed in-house, private equity firms because they are heavily invested participate directly in guiding their portfolio companies. In contrast, publicly-traded funds typically hold only small fractions of a large number of companies and as such are not incentivized to actively monitor or guide portfolio companies.
In fact, data support the idea that the some private equity funds outperform public markets even after accounting for high fees. The best performing funds are effective in selecting, guiding and resourcing promising companies and quickly sunsetting laggards.
Causes of current concern are; that much of the venture capital-funded companies currently are less innovative, recently several of these companies have seen their pre-IPO valuations tumble, because the investment cycle, for each company can be longer it may be harder to assess performance and valuation, because pensions and endowments hold large positions in these funds they may less able to quickly sell off.
What else is driving the increase in private equity? First, legislation has made it easier to form large private equity funds. Second, being a public company seems more expensive and difficult these days. Third, privately-held companies can boost returns by being more leveraged-hold more debt. Finally, demand for private equity is partly driven by a large number of mid-size companies who are effectively not funded by larger American banks. Read the article for more detail.