Private equity will leave public markets behind

Steven Tredget

Steven Tredget

It is already a Happy New Year for Apple investors as the company’s valuation hit $3tn (£2.1tn) on January 1.

The gains cap a strong run for shareholders after the shares increased by a third in 2021 (and 80 per cent in 2020), a story repeated across the so-called FAANG stocks as the pandemic continued to buoy tech businesses in 2021.

The problem for investors is that there are fewer Apples to invest in these days, or any listed stocks for that matter. Data shows that over the past 10 years, the universe of public equities has shrunk as much as 30 per cent across major economies. The flip side of this is that more companies are remaining private for longer, with profound implications for all investors, whether they be private punters or fund managers. 

Why is this happening? Low interest rates have encouraged pension funds and other institutional investors to pour money into higher-yielding private asset classes, including private equity. Private equity is using that money to back private companies, reducing the need for them to tap public markets through IPOs. 

Today, the industry is sitting on a $2.5tn war chest, ready to deploy across new investments. Often, they are looking to back high-growth technology companies – often the Apples of tomorrow who may now never make it to the public markets. 

And who would blame the founders of these companies for shunning a floatation? Being the chief executive of a listed company can be burdensome and at best a distraction from running the business. IPOs are expensive once you add up the cost of hiring underwriting banks, lawyers, accountants and PRs.

Post-IPO, there is the ongoing expense and regulatory burden associated with being a listed company, including the requirement to publish detailed financial statements on a regular basis (which often contain confidential information that is valuable to competitors). 

By contrast, life as a PE-backed business can be easier and advantageous. Beyond the money, entrepreneurs often opt for private equity backers to enjoy their longer-term outlook and the know-how they bring to the table: how to expand their business overseas; how to launch an e-commerce channel; and how to build an effective marketing campaign and win new customers.

The result of these partnerships is strong investment returns for all stakeholders. For example, the LPX UK Listed Private Equity Index has returned about 29 per cent over the past 12 months compared to about 13 per cent for the FTSE All-Share Index.

To be sure, public markets continue to attract capital, in particular into passive markets, thanks to financial innovations such as exchange-traded funds that have made it cheaper and easier to invest and which attracted $1tn in fresh funds in 2021 alone. At the end of the day, however, many ETFs have fewer securities to track, and often they are slow-growing, old-economy companies. 

Up until recently, investing in private capital has been difficult, with investors needing to cut multi-million-pound cheques to join the party. This is no longer the case. There are now multiple access points into this growing asset class, from buying shares in listed private equity businesses to investing in PE investment trusts that buy direct stakes in private companies or pursue a fund-of-funds strategy.