Private equity has become the return-boosting investment class of choice for many asset managers in recent years, for all the accusations that buyers are overpaying for deals amid an overleveraged bull market. But could the shift away from public markets have a potentially more sinister outcome than luring yield-hungry funds into overpriced unlisted investments? Could it pose a threat to capitalism itself?
Martin Gilbert, vice chairman of Standard Life Aberdeen Plc, told Bloomberg Television earlier this week that asset owners are making “quite a big shift” to private equities from public markets. He estimates that the percentage of the world’s assets in non-public markets will climb to 20 percent from about 15 percent currently.
Sovereign wealth funds are at the vanguard of this drift away from listed assets. A report published on Thursday by the International Forum of Sovereign Wealth Funds, which represents more than 30 investment managers around the world, shows that the number of SWF deals was evenly split between public and private investments in 2015. Last year, though, non-public transactions accounted for more than 65 percent of direct investments as measured by the number of transactions.
Public markets around the world are becoming less liquid. Between 1996 and 2018, the number of publicly traded U.S. companies declined by a third to 5,363, according to the IFSWF, which cited data compiled by the World Federation of Exchanges. A corresponding decline in the number of initial public offerings saw the number of listings in which SWFs acted as anchor investors around the world slump to 17 last year from 38 in 2017.
SWFs invested $12.85 billion in unlisted companies in 2018, compared with the $10.57 billion allocated to publicly traded stocks. In technology and telecoms, for example, the $100 million that went to listed investments was dwarfed by the $3.4 billion allocated to private companies.
In dollar terms, the proportion of investments made in unlisted companies in 2018 was about the same as in 2016 and 2017, even as the absolute total declined by almost a fifth last year. That fall was “possibly driven by concerns over asset prices and even greater competition in private markets,” according to the IFSWF.
Anne Richards, the Chief Executive Officer of Fidelity International, reckons companies in the U.S. raised about $2.4 trillion privately last year, some $300 billion more than the public markets provided in capital. Because companies are staying private for longer, their founders and initial backers win more of the value from their growth; IPOs become more about capturing that value than as a means of securing the capital to build the company in the first place. And that makes Richards nervous.
“This process marks a de-democratization of capitalism,” she said in a speech to the CFA Institute in London earlier this month. “A growing proportion of financial assets in private hands, means less public participation in the economy. It means that the society in which we work has less skin in the game of capitalism than has historically been the case.”
If sovereign funds, venture capital firms and other big asset owners can trap the wealth created by innovative firms to the exclusion of, or at the expense of small and retail investors—and the IFSWF report suggests SWFs are getting in earlier than ever in the development stages of the companies they invest in—public markets risk becoming just liquidity pools for the secondary trading of shares, rather than sources of capital.
As Richards says, financial markets operate via a contract with society. But the credit crisis unleashed on the world a decade ago has undermined that covenant in the eyes of many people, not least because ostensibly private financial risk turned out to be underwritten by public money.
If the benefits of capitalism accrue to an ever-shrinking pool of capital and labor continues to enjoy scant reward from the system, more members of society will start to question the merits of the prevailing system. By underwriting more private investments, sovereign funds could be contributing to the hollowing out of trust in capitalism itself.