The case for private markets investing is mounting, according to various industry sources that liken the vast opportunities within private markets to the Marvel Multiverse. In an investment brief, Hamilton Lane cited private markets represent a “much larger investable universe” as the No. 1 reason private investments may warrant consideration in most portfolios for high-net-worth (HNW) individuals.
That ever-expanding universe of innovative, growth-oriented companies comprises 17,000 private businesses with annual revenues of more than $100 million, according to Source Capital IQ, as of February 2021, cited in the brief. Comparatively, there are only 2,600 public companies of the same size.
“By this measure,” according to the Hamilton Lane brief, “investors allocating only to public equities are limiting their opportunity set to just 15% of the largest firms in the U.S.”
In the brief, research conducted by Professor Jay R. Ritter at the University of Florida found the number of public companies is dwindling, shrinking from 7,810 at the beginning of 2000, to 4,814 at the end of 2020.
Concurrently, the ranks of public companies are thinning with the indices that invest in them becoming more top-heavy. Case in point, within large-cap indices, the vast majority of market cap has become concentrated in a small number of firms. According to the Hamilton Lane brief, just five stocks account for about one-fifth of the S&P 500 index, as of March. “For investors allocating solely to public equities, this further limits their exposure to the broader corporate universe.”
Beyond the dimensions of the “investable universe” private markets present to wealth advisors and their clients, there are three key factors to keep in mind when considering private market investing:
Innovation and Growth
Steve Jobs, considered the “Master of Innovation,” once said, “I want to put a ding in the universe.” With that, he had much to say on innovation, even in down markets:
“Innovation distinguishes between a leader and a follower…A lot of companies have chosen to downsize, and maybe that was the right thing for them. We chose a different path…The cure for Apple is not cost-cutting. The cure for Apple is to innovate its way out of its current predicament.”
Innovation is predominant in the companies that represent the investible universe of private markets. Think of industry disrupters like Carvana and Tuft & Needle. And their potential to experience significant growth can be exponential. The Hamilton Lane brief discusses that most of these companies never go public at all, but those that do are waiting longer to make the transition. According to Ritter’s research findings, “Initial Public Offerings: Updated Statistics,” he writes:
“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. 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.”
Head of Strategy Kosta Etus, CFA®, Dynamic Investment Management, weighs in on innovation and growth within private market investing, “There are more opportunities in this larger universe of innovators for growth and returns to help supplement and/or complement the deficiencies in public markets.”
The Hamilton Lane brief points out, “Private markets represent a much wider swath of businesses, and often these companies are in the dynamic and innovative phase of their development.”
Resiliency
Etus also notes that private investments are typically more resilient during tough times. He explains, “Much of this is due to the illiquidity of private companies in which investors are much more stable and not reactionary to market headlines. This can allow the investment to realize its long-term potential in a better way.”
Source: Hamilton Lane Data, Bloomberg (July 2021). Past performance is no guarantee of future results.
According to the brief, perhaps the most underappreciated aspect of private markets’ outperformance is in how it was achieved. The brief goes on to read: “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.
Historical Performance
There’s data to prove what some may consider the No. 1 argument for investing in private markets: Performance. The Hamilton Lane brief advocates that the statistics speak for themselves:
- Over the past three years, private equity has generated a premium of 38% over public equities.
- One dollar invested in the private markets in 2018 would be worth $1.96 today, compared with just $1.42 for a dollar invested in public equities.
- Private real estate and private credit have performed quite well compared with public equities when you consider their different risk profiles.
- Private equity and private credit have each outperformed global public equity and credit markets, respectively, in 19 of the last 20 years.
Traversing the Private Market ‘Multiverse’
McKinsey’s “Global Private Markets” annual review reveals several critical growth insights. Among them:
- Global private equity (PE) net asset value has multiplied eight times since 2000, almost three times as fast as public market capitalization, which has grown approximately 2.8 times over the same period. Yet it is important to keep in mind that even after two decades of torrid growth, private market AUM remains miniscule next to public markets, coming in at less than 8% of total public equity market capitalization and 3% of public debt.
- The outlook for continued growth in private market AUM, from both traditional and new sources of capital, remains strong. For all the attention they receive, LP allocations (pension funds, sovereign-wealth funds, etc.) to private markets still tend to account for only 5% to 15% of portfolios. And according to Preqin, LPs are underweight relative to their target allocations for PE.
- All the evidence suggests that despite the record amount of capital committed to PE over the last several years, there’s likely more to come.
When advisors are exploring the multiverse of private market investing with their HNW clients, Etus points out there can also be higher risk. “Dynamic recommends not exceeding 10% to 20% in alternative investments for HNW individuals. That said, larger endowments with very long-term horizons are sometimes allocating upwards of 30% to 40% in private investments.”
For help navigating private market investing, advisors are encouraged to contact Dynamic’s Investment Management team via the Digital Dashboard.
