The rise and rise of private markets

Photo by Sven Scheuermeier on Unsplash

Private markets are all the rage. 

Anyone who reads the FT or Morgan Stanley’s excellent research output would be forgiven for thinking that private markets are becoming the dominant investment genre.  

Of course, they are still small fry relative to public markets, which dwarf private assets in size, liquidity and just about every other meaningful metric. Apart from, perhaps, sex appeal. Because, in the words of Will Ferrel’s fashion mogul Jacobim Mugatu, “private markets are so hot right now”. And they are getting hotter. 

An economic miracle. 

Time is linear (unless you are Marty McFly). But the story of capital markets is not.  

Before the emergence of the mature public markets we see before us today, there were only private markets. Without entrepreneurs and early-stage investors taking risks and building companies (and countries) literally from scratch, we would have no investment banks, no stock market indices, no Bloomberg, and no Robinhood.  

Around such entrepreneurs cluster moneymen seeking returns. Investors have been acquiring or making minority investments and lending to privately held companies for centuries. As far back as the 1300s, Venetian moneylenders traded in debt issues. In the 1600s, various East India companies issued stock that led to a financial boom, (and then bust). This was a form of economic enlightenment, mirroring the cultural revolution occurring all over Europe.  

In the 20th Century, public markets exploded in size, and the narrative focused on large, liquid companies that captured the attention of bankers and investors. Stock exchanges emerged to bring greater transparency and efficiency to the art of trading stocks. And an entire ecosystem of players has emerged to sell baby boomers the economic miracle of compound interest. As a result, public markets ballooned. 

The empire strikes back. 

Throughout this period, it was simply assumed by practitioners and policymakers that “progress” meant “public”. Private markets were old hat; fragmented, inefficient, risky, a throwback to a less enlightened time characterised by parochial entrepreneurialism. IPOs, M&A and trading income dominated bank earnings. The awkward complexities of private equity, debt and real estate simply weren’t on Wall Street’s radar. 

How things change. Between 2000 and 2018 the number of private equity-backed companies in the US rose from less than 2,000 to nearly 8,000, whereas publicly listed companies in this period fell from 7,000 to about 4,000 (although listed firms are still worth more than ten times the private-equity backed ones). For those of us on the front lines, the shift in sentiment towards private markets is tangible. We see it in the newsletters, tweets that ping across our screens every day, and we hear it in conversations with clients (and podcasts).  

Everyone wants a piece of the action. 

Alpha at scale. 

Alternatives have tended to offer better returns than public equity in the past decade. Over the past 30 years, US buyouts have generated average net returns of 13.1%, compared with 8.1% for an alternative private-market performance benchmark. Yes, buyouts attract all the headlines, but the growth of venture investing has been impressive too. 

Heavyweight institutional investors like private markets for the same reason they’ve always liked them – they provide alpha at scale. Superabundance is real and pension funds, endowments, SWFs and the like need to deploy capital somewhere – and private markets are willing beneficiaries. Headline-grabbing performance has attracted investment flows, which have in turn fostered the maturation of the industry – more players, more indices, more service providers.  

So much so that private markets are starting to look less like a random conglomeration of dealmakers and more like a mature industry, complete with MBAs and conferences that promise to do conventional things like “connect like-minded thought leaders to drive mutually beneficial outcomes”.   

The money has to go somewhere. 

With the kudos and the media hype comes the pressure to perform. The growth of private markets has tracked the expansion of central bank balance sheets, and the current souped-up iteration of the industry is yet to prove its resilience through a full credit cycle.  

But those that question the sustainability of private market returns are missing the point. Certainly, big beast allocators scrutinize aggregate returns when performing portfolio construction. But even when returns decrease and institutions allocate away from the big buyout funds and their high-profile kin, direct investments and co-investments will persist.  

The fact is that investors have more money to put to work than ever before. Global financial capital increased 53% from 2000 to 2010, reaching some $600 trillion. And it’s projected to swell to $900 trillion by the end of 2020. Low rates, deregulation and financial engineering have unleashed a vast volume of financial assets so far this century. The money has to go somewhere.  

Too exciting to ignore. 

What about individual investors? HNWs and their ultra cousins will likely continue to be captivated by the allure of private markets, regardless of broader industry trends. Venture investing in particular is just too exciting to ignore, something we’ve witnessed first-hand since launching our private deals platform, 3BC. 

Attitudes have changed so much in recent years, and that is being driven in part by famous (and sometimes infamous) founders who choose to keep their companies private for longer. Going public used to be the epitome of corporate success. Today, many top companies avoid listing for strategic and financial reasons, choosing to tap private markets for huge investment rounds. In many ways, it’s never been less attractive to be a public company; so can you blame management teams for wanting to kick the cost of regulatory compliance down the road whilst maximising their own financial returns over the long term? 

Make no mistake – the rise of the privately held unicorn is adding much needed credibility to private markets by bringing in strategic investors like corporate ventures, SWFs and established financial institutions. Just look at the cap table of companies like SpaceX and Gojek and you’ll get the picture.  

Here we should add that public markets have had a fantastic run. But returns are being driven by an ever-narrower set of technology giants which now make up more than a quarter of passive, and ETF, portfolios in the US. As public markets have become more liquid and dominated by passive flows, wealthy individuals have sought out ways to diversify and decorrelate returns. The illiquid and restrictive nature of private assets provides the perfect counterweight to the untrammelled freedom of public markets, and the sacrifice is reflected in the returns available to those who are able to lock capital away over long periods. 

The investor-centric business. 

Traditional categories are collapsing, and investors are becoming increasingly agnostic and pragmatic about how they access alpha. They continue to seek returns from public markets via traditional fund structures, but they are layering on private investments across a range of assets and vehicles. The investment landscape is becoming more sophisticated and holistic, forcing wealth managers to respond with new products and ways of doing business. 

This trend is partly driven by FOMO. Since companies are staying private for longer, there is a very real danger that investors who restrict themselves to public assets will miss out on the next phase of wealth creation. They simply cannot access the next generation of leading companies until much later in their life cycle, missing out on huge upside. Amazon listed at around $300m in 1997. Just over 20 years later, it was worth a trillion dollars. Uber on the other hand listed at $84.2bn. Amazon-style returns in public markets are simply no longer realistic. So, investors are turning to private markets to boost their returns.  

We started our business partly in response to this movement. Unlike many (certainly not all) financial services firms, which first create products and then look for clients to buy them, Three Body Capital is customer centric. We have carefully designed our business to offer investors one thing above all else: access. Our hedge fund provides cost-efficient access to absolute returns in public markets, and our private deals platform, 3BC, offers access to opportunities in private markets across a range of asset classes and structures.  

The distinction between public and private markets is a hangover from the days when only institutions could access private markets in a meaningful way. Now, individuals can enjoy the rewards (and of course the risks) of investing in private assets. Naturally, private and public markets are not mutually exclusive. They can grow together, and they will. These two very different methods of investing are two sides of the same coin. 

Wealth begets wealth, after all.