Trends in private markets

01 November 2022

Please note: The article does not constitute advice or any form of investment recommendation. The securities quoted are included for illustration purposes only and should not be interpreted as recommendations.

With traditional equity and bond markets facing higher volatility and lower returns, investors are looking further afield for diversification and performance drivers. One option attracting more attention is that of private markets, an asset class historically inaccessible to all but the most savvy investors. In 2021, it’s estimated that nearly $1.2 trillion¹ flowed into private markets, suggesting that they are gaining traction with a wider audience.

In this article, we discuss some of the long-term trends in private markets, and why the asset class has arguably become more relevant in today’s market environment.

Long-term shift from public to private

There has been a major shift in the corporate landscape over the past few decades in favour of private markets. The number of private companies globally has grown sharply, and they now outnumber listed ones by almost seven to one.

_{Please note: Past performance and simulated past performance are not reliable indicators of future results. The value of investments can fall as well as rise and you may get back less than you invested.}

This is in part due to strong growth in available capital, which means companies no longer have to list on the stock market to fund their expansion. According to Shenal Kakad at Barclays Private Bank, an investor pivot from public to private has been gaining momentum: “After a pandemic-related dip, demand for private markets soared last year, with private assets under management reaching an all-time high of $9.8 trillion.² At the same time, the public sector has shrunk as fewer companies choose to go public, and more public companies are acquired or taken private.”

In the US, the fall in the number of listed companies following the Global Financial Crisis in 2008 still hasn’t fully reversed (see chart), as increased regulation and high costs have made going public less appealing.

Companies are staying private for longer

There is growing evidence that companies are remaining private for longer than in the past, helped by the record levels of available funding. The median age of US technology companies going public was 12 years in 2020 and 2021, compared to a median age of eight for the period 1980-2021.³ For comparison, some of today’s tech giants were much younger at IPO – three years for Amazon and eBay; six for Google. Many companies are choosing to delay a public listing because of high volatility in listed markets, and there has been a marked slowdown in IPOs globally in 2022 to date after a record year in 2021⁴.

Companies are also growing larger than ever in private. There has been a sharp rise in the number of unicorns (private companies with a valuation of $1 billion or more) in the past five years – from 165 at the start of 2016 to 743 by mid-2021⁵. Yet according to PWC, of the 1,034 companies that acquired unicorn status during this period, only 28% exited (through M&A, IPO, SPAC or by going out of business) within the same timeframe, suggesting that there could be plenty more innovation and growth in the private space to come⁵.

And by the time unicorns are choosing to list, many of them have already become major disruptors and players in their industry – much like Uber and Facebook, both among the largest ever IPOs, which listed after 10 and eight years respectively.

Accessing the private-for-longer trend

The rise of continuation, or secondary market, funds is also supporting the trend. Private equity fund managers, or General Partners (GPs), typically manage a portfolio of assets for around 10 years, at which point the original investors would normally expect to cash in their investments. However, GPs are increasingly holding onto strong-performing assets by transferring them into new vehicles, with a view to extracting more value before exiting. These vehicles allow GPs to return cash to original investors, using liquidity provided by secondary investors, while offering them more flexibility around when to sell.

As Duncan Richer from Barclays Private Bank explains, continuation funds are not new but are growing in market share: “They accounted for 84% of GP-led transactions in 2021, which totalled $68 billion⁶. While there are additional risks as well as benefits associated with this type of fund, their growth signals a structural change to the private equity market – and new potential opportunities (as well as risks) for investors.”

It’s clear that looking only at public markets significantly narrows investors’ opportunity set, which explains why private deals are considered more frequently in today’s tough environment. Waiting until companies go public could also mean missing out on a significant share of their value creation.

That said, it’s important to recognise that private markets aren’t necessarily the solution for everyone. They are often complex, illiquid and bring higher idiosyncratic risks than public markets. For those reasons, private markets are still only really suitable for sophisticated investors.

Private markets in challenging times

In the current environment of slower growth, higher inflation and rising interest rates, portfolio diversification is more important than ever. While private markets are not immune to the weaker outlook, they tend to have a low correlation to public markets, so adding a private markets allocation to a traditional equity-bond portfolio could potentially improve portfolio returns.

There are, however, trade-offs in terms of both additional risks and reduced liquidity, so it’s important to consider any portfolio changes in the context of your overall financial goals, time horizons and risk appetite.

Diversification opportunities

Private assets encompass a range of asset types (private equity, debt and real assets), within which there are further sub-categories, each with their own characteristics and drivers. Investing in a blend of strategies with different risk-return profiles across the market cycle could potentially help build a more resilient portfolio allocation.

A private markets fund will typically invest over several years, in an effort to smooth the effect of any short-term volatility in pricing. Investing across different fund vintages can diversify the exposure further, and could ultimately create a self-funding portfolio, where distributions from earlier vintages can be reinvested into later ones.

However, building a diversified private markets portfolio is a long-term endeavour. Each investment will typically have an investment horizon of 7-10 years, but sometimes longer depending on market conditions. This comprises the investment phase (often 3-5 years), followed by the harvesting phase where investors may start to receive distributions, and finally liquidation.

Illiquidity premium

Investors who lock up their capital for longer periods are typically compensated with an illiquidity premium, which can boost portfolio returns. It is difficult to quantify this premium accurately, due to the irregularity of cash calls and income distributions. While past performance is never a guide to future performance, the average historical illiquidity premium is between 2% and 5%, according to our estimates⁷, as we discuss in our article ‘In search of a rich illiquidity premia harvest in private equity’. These are also in line with the findings of several other industry research papers⁸.

There are, of course, no guarantees. Private markets can be difficult to navigate, often requiring specialist expertise, networks and access to find high-quality deals. And there is significantly higher dispersion in returns among private asset managers, so choosing those with the relevant skills and experience, and doing thorough due diligence on any potential opportunities, are essential.

Lower volatility

Whereas listed markets are often subject to sharp short-term swings, often overshooting, private markets are somewhat sheltered from such volatility, as there is no daily pricing. Investors may receive fewer updates, typically on a quarterly basis, by which time during turbulent markets the worst may have passed. This can help you resist the urge to panic-sell and stay focused on your long-term investment goals – a subject we explore in our article Diving into private assets and the liquidity conundrum.

Long-term commitment

For investors able to accept the higher risks and make a long-term capital commitment, private markets can offer exciting opportunities to invest in innovation and future disruptors, as well as build a diversified portfolio that better reflects the breadth of the evolving corporate landscape.

Please note: Past performance and simulated past performance are not reliable indicators of future results The value of investments can fall as well as rise and you may get back less than you invested. The securities quoted are included for illustration purposes only and should not be considered investment advice or recommendations.

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