Public to Private Equity in the United States: A Long-Term Look
Publish Date: 04-08-2020
Source: Morgan Stanley
Synopsis: · The equity capitalization of the U.S stock market is roughly 27 times the size of AUM for buyout funds and more than 80 times the size of venture capital funds. · There are about 3,600 public companies in the U.S. today, about one-half as many as there were in 1996 and three-quarters as many as there were in 1976. · Further, companies have raised more money in private markets than in public markets in each year since 2009. For example, companies raised $3.0 trillion in private markets and $1.5 trillion in public markets in 2017.3 These changes in how investors invest and how companies raise capital have important implications for holding periods, the perceived volatility of the returns, and liquidity. · The right panel of exhibit 11 shows that university endowments, which collectively control assets of more than $600 billion, have undergone an even bigger shift. · The pattern in asset allocation that we have seen is consistent with the search for returns. The left panel of exhibit 11 shows that a large sample of state and local government pension funds in the U.S., with total assets estimated to be $4.5 trillion, · Return dispersion, the difference between the best and worst funds, is very wide in private equity relative to other asset classes. Venture capital dispersion is higher than that of buyouts, but both are high. That means the ability to identify and gain access to skillful general partners is crucial. Research shows that skill in fund selection is a significant determinant of returns and that access to the best managers was key to the success of endowments such as Stanford and MIT. The leaders have done better than the followers.35 · First, the capital is locked up for a period of time, which limits the ability to buy high and sell low. Second, the smoothed returns provide a perception of stability that may offset the tendency to overreact to short-term losses. · Increasing returns are pronounced in intangible-based businesses, and there has been a growing gap between the intangible spending of the large firms relative to small ones. · The propensity to list is roughly one-half of what it was in the mid-1990s · For example, the average market capitalization of a public company in 1976, measured in 2019 dollars, was $686 million. By 1996, that average grew to just under $1.8 billion. Today, the average market capitalization is nearly $10.4 billion · There is debate about whether the size effect, a factor that reflects the fact that small-capitalization stocks deliver higher returns than the capital asset pricing model indicates, has remained intact as the number of stocks has dropped. · Only about 10 percent of funds charge less than 20 percent for the profit share, or carried interest, component of fees. · In addition, a number of marketplaces, including SharesPost, Forge, EquityZen, NASDAQ Private Market, ClearList, and Carta, provide liquidity for sellers and buyers. About one-half of private companies surveyed allow their employees to sell shares. · The sunlight of an IPO can be the best of disinfectants from overvaluation and can improve productivity · We saw that the expected returns were lower for large buyout funds that followed smaller funds. The same is true for venture capital, but the effect is even more pronounced.15 · As exhibit 44 suggests, every 1 percent shift in asset allocation from public to private equities represents about $390 billion in assets. For context, the commitment to U.S. buyouts and venture capital were approximately $315 billion in 2019. · In reality, flows often mirror past returns. Investors do in the present what they should have done years before. · As with most corners of the investment world, there will be pressure on fees for many buyout and venture capital firms.173 Similar to active managers of public equities, firms that demonstrate skill will be able to charge above-average fees. But investors will likely challenge the lower tier of the industry to lower fees.
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