In financial markets there has been plenty of talk about the recent Morningstar observation that there are now more Exchange Traded Funds (ETFs) than listed stocks in the US, with over 4,300 ETFs compared to approximately 4,200 stocks.
The 10 largest companies now occupy a growing share of benchmark indices with 34% of the S&P 500 index weight, 55% of the Nasdaq Index and 47% of the S&P/ASX 200 Index.
To highlight the decline in listed companies, the following chart from the World Bank Group highlights this steady decline in public listings since the boom of the 1990’s.
The reason for this steady decline is threefold:
- The increasing regulatory burden and costs of being listed;
- The global phenomenon of corporate consolidation where it is far easier to grow a company by acquisition; and
- The increasing availability of private capital.
Historically, if you wanted additional capital for your growing business you either went to the bank or, if your company was large enough, you listed on a public exchange and issued new shares. Of course, the public listing was also a way crystalising the value of the company and reducing your exposure, cashing out your chips.
Private Equity (PE) investing has been around for a long time, the first two venture capital firms were launched in 1946, however, it is only in recent times that such funds have moved from the world of institutional investors into the domain of mum and dad investors.
With a move into the retail space, the amount of invested private capital has risen to circa US$8 trillion in 2024. While this is still dwarfed by the global market capitalisation of listed companies at US$126 trillion, more and more companies are deciding to remain privately held – as highlighted in the chart above.
Put simply, private companies no longer need to seek out willing banks or public listings in order to gain access to needed capital or liquidity events.
Strengthening portfolios with private assets
PE investments can help diversify portfolios and tap into the potential of private companies – from startups to mature organisations with proven value. Such investments have also historically commanded a premium (excess return) that asset owners can capture due to the illiquidity of the underlying investments.
The following table from McKinsey & Company highlights that while PE funds have underperformed strong global listed markets in recent years, over the longer term, they have provided higher returns.
Paradoxically, the underperformance in the last three years has been due to a decrease in merger and acquisition activity and a fall in the number of private companies being listed on global stock exchanges, the very aspect that has led to the rise of PE investing.
This has led PE firms to hold onto investments for a longer period, thereby delaying the higher expected returns on capital.
As noted by global PE manager, Hamilton Lane, more companies are choosing to stay private longer, with the average age of a new public company increasing from 4.5 years in 1999 to over 12 years in 2020.
While returns from PE funds can underperform listed markets in the short term, as noted above, the variance of returns between managers can be large as noted in the following chart from asset manager Schroders.
However, it is this variance in returns that can provide the diversification of returns that benefit portfolios. The following chart from JP Morgan highlights how allocating 30% of a portfolio to alternative assets (PE funds in this example) can increase the annualized return while decreasing the overall level of volatility (risk).
While the optimal allocation for each individual depends on your risk tolerance, liquidity needs, investment horizon and existing portfolio composition, Cambridge Associates has reported that large endowment funds typically allocate approximately 30% to PE.
Valuation metrics of Private Equity
The following chart from McKinsey & Company shows that the valuation gap between PE companies and listed companies has decreased in recent years but PE companies still lag their listed counterparts. Should mergers and acquisitions and public market listings open up once again, it bodes well for PE managers who are holding onto quality assets, awaiting the right time to sell off prime assets.
Why now?
With increased global volatility, potential trade wars and climbing listed equity valuations, we believe now is the time to start diversifying your portfolio. Traditional diversifiers such as bonds look like they will struggle in the years ahead thanks to the unusual combination of central banks cutting cash rates at the same time that inflation remains stubbornly at the upper end or above most central bank target ranges.
We believe that increasing your exposure to Private Assets and Private Equity in particular could bolster your portfolio in the years ahead.
If you would like to know more about Private equity, please see our Guide to Private Equity – Unlocking the opportunity which can be found here or reach out to us for a personalised discussion.
Andrew Aylward is Chief Investment Officer at Keep Wealth Partners.
For more information contact us on 03 8610 6396
Keep Wealth Partners Pty Ltd (AFSL 494858)
This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from a financial planner who can consider if the strategies and products are right for you.
