A dynamic and innovative global economy still offers investors plenty of long-term growth opportunities. The caveat: You may want to look beyond public markets to find them.
Increasingly, companies are choosing to stay private longer, or never go public at all, and this could have large implications for investors. As much of the corporate world’s growth, innovation – and returns – occur outside of public markets, an allocation to private markets may prove beneficial to meeting long-term investment objectives.
The following investment brief explains the opportunity set within private markets, and why private investments may warrant inclusion – or at least consideration – in most portfolios. The rationale can be summed up in four main points:
Private Markets Represent a Much Larger Investable Universe
When it comes to investing, public companies represent only a small, shrinking tip of a much larger iceberg. Currently, there are only 2,600 public companies with annual revenues of more than $100 million, compared with 17,000 private businesses of that size.1 By this measure, investors allocating only to public equities are limiting their opportunity set to just 15% of the largest firms in the U.S.
And the number of public companies is dwindling, shrinking from 7,810 at the beginning of 2000, to 4,814 at the end of 2020.2
At the same time the ranks of public companies are thinning, the indices that invest in them are becoming more top-heavy. Within large-cap indices, an enormous amount of market cap has become concentrated in a small number of firms. Just five stocks account for about one-fifth of the S&P 500 index, as of 3/31/21. For investors allocating solely to public equities, this further limits their exposure to the broader corporate universe.
Private Markets Companies Often Experience Much Innovation and Growth
Another reason to consider an investment in private markets is that this is where firms have the potential to experience significant growth. Most companies never go public at all, but those that do are waiting longer to make the transition.
In the technology space, the age, on average, of a new public company has gone from 4.5 years in 1999 to more than 12 years in 2020.3 As more tangible examples, Uber and Airbnb, two of the 10 largest-ever tech IPOs, waited 10 and 12 years, respectively, before going public, long after they had disrupted the industries in which they operate.
Over the past three years, private equity has generated a premium of 33% over public equities.
Historical Performance Has Favored Private Markets…And there’s Data to Prove it
Perhaps the biggest argument for investing in private markets is the most straightforward: Performance. Here, the statistics speak for themselves. Over the past three years, private equity has generated a premium of 33% over public equities. One dollar invested in the private markets in 2017 would be worth $1.52 today, compared with just $1.19 for a dollar invested in public equities. Private real estate and private credit have also performed quite well compared with public equities when you consider their different risk profiles.
GROWTH OF $1
More impressive yet is the consistency of outperformance: Private equity and private credit have each outperformed global public equity and credit markets, respectively, in 19 of the last 20 years.
One could argue that after a protracted period of outperformance, perhaps the tables are due to turn, and favor public equities. But here’s what’s interesting: Relative to history, it’s the public equity market where performance has been most stretched. The S&P 500’s current 10-year return is in the 93rd percentile of its return profile over the last 30 years. Private equity’s current 10-year return, meanwhile, is in the 73rd percentile.
ROlling 10-year return distributions
Source: Hamilton Lane Data, Bloomberg (January 2021)
Private Markets have Shown to be Especially Resilient During Tough Times
The most underappreciated aspect of private markets’ outperformance is in how it was achieved. Namely, demonstrating resilience during market downturns. The chart below shows the lowest five-year annualized performance of various markets over the past 25 years. Developed market buyout and private credit never had negative returns over any five-year stretch.
Lowest 5-Year annualized performance
In its worst five-year period, venture capital did experience a loss greater than global equities. But this could be deemed one of the riskier forms of private market investing, and its returns in that worst five-year period did not lag far behind other classes. In short, private markets have largely outperformed their public market counterparts, but often with lower downside risk.
One might say that the different reporting requirements associated with private investments mask when an investment has lost value (i.e., private market values are typically disclosed on a quarterly basis, compared to real time pricing associated with public markets). But for the end investor, this could also be viewed as a positive feature: Less frequent reporting and redemption limitations remove some of the negative behavioral elements often associated with investing. When investors don’t view prices daily, they may be more patient with the investment, hopefully realizing its full potential value over a longer time horizon.
Private markets represent a much wider swath of businesses, and often these companies are in the dynamic and innovative phase of their development.
Conclusion: Broaden the Investment Horizon
As investors seek to maximize the return potential of their portfolios, they may want to broaden their scope. Private markets represent a much wider swath of businesses, and often these companies are in the dynamic and innovative phase of their development. Historical returns also may make a case for private market investing, as private equity, private credit, and private real estate have each outperformed their public counterparts consistently over the past two decades.
Innovative fund structures are making private market investments more available to high-net-worth and ultra-high-net worth investors. Of course, there are still factors these investors should consider before entering the space: Private markets are typically less liquid and require longer time horizons, for instance. But given the opportunity, investors may want to take a closer look to determine whether allocating to the private markets asset class makes sense as part of their broader investment strategy.
1 Source Capital IQ, as of February 2021
2 Source: Research by Professor Jay R. Ritter, University of Florida
3 Source: Research by Professor Jay R. Ritter, University of Florida in Initial Public Offerings: Updated Statistics
S&P 500 Index: The S&P 500 Index tracks 500 largest companies based on market capitalization of companies listed on NYSE or NASDAQ.
MSCI World Index: The MSCI World Index tracks large and mid-cap equity performance in developed market countries.
BofAML High Yield Index: The BofAML High Yield index tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
MSCI World Energy Sector Index: The MSCI World Energy Sector Index measures the performance of securities classified in the GICS Energy sector.
S&P Global Infrastructure Index: The S&P Global Infrastructure Index tracks the performance of 75 companies from around the world that represent the infrastructure industry.
FTSE/NAREIR Equity REIT Index: The FTSE/NAREIT All Equity REIT Index tracks the performance of U.S. equity REITs.
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