Opinion Of The Week: Wealth Sector, Regulators Must Wake Up To Private Markets' Rise
Private market investing is the new hot trend, and has been building momentum, but the world of regulation and policymaking still hasn't fully caught up, and even the mainstream media still treats the area as fringe, rather than mainstream. It's time for an adjustment.
A couple of weeks ago, I mused about a speech by a high-ranking Securities and Exchange figure about the need to make private markets more transparent. And the “so-what?” of this is that unless changes come, regulators like the SEC and others won’t think that these non-public markets are suitable for the mass public.
And that’s bad because evidence mounts that private equity, venture capital, private credit, infrastructure and forms of real estate should be in portfolios, and not just those of ultra-wealthy people that many of our readers focus on. According to the most recent SEC data, for the 12-month period from July 1, 2021 through June 30, 2022, private market offerings accounted for about $4.45 trillion in capital raising; whereas during that same period, publicly raised funds accounted for roughly $1.23 trillion in fundraising. That’s roughly 3.5 times more capital raised in the private markets than in the public markets. The gap appears to be getting wider.
Since the end of the dotcom bubble 23 years ago, and arguably also the US Sarbanes-Oxley accounting rules that came in after the Enron scandal, there’s been a secular shift from public to private markets. And, after the 2008-2009 financial crash and more than a decade of ultra-low/negative interest rates, the hunt for yield reached almost manic proportions, driving this shift even more. It’s hard for me to open my email without yet another firm expounding the wonders of private markets and direct investing.
But if an increasing part of financial returns are privately driven, rather than from the stock market, where does that leave those who aren’t “sophisticated” or “accredited” investors? Must they accept whatever crumbs fall from the table?
It’s true that the SEC and other regulators, such as the Financial Conduct Authority in the UK, are trying to bring out structures or rule changes that might open access a bit more. (Given the pace of regulatory change, I am not holding my breath.) And it is also the case that some private market investments can be tapped via a closed-end, listed fund. In this case, however, investors and advisors must understand that share prices in these funds can trade at a wide discount to net asset value. There are also “liquid alternatives” in the form of European UCITS funds, but in this instance, the underlying assets must match daily liquidity access. That’s unlikely with a private equity strategy, for example, or most forms of real estate funds.
However, until some of these access issues are ironed out, it means that millions of people saving for retirement and other reasons cannot get a ticket to the main show in town if regulators don't let them. That’s politically, socially and economically foolish, because it will only underscore how “the rich” are seen as getting richer relative to the rest of us. As populations age and birth rates fall, it is particularly unwise.
It’s perhaps unsurprising that one of the big beasts of the private equity jungle, Kohlberg Kravis Roberts, aka KKR, is banging the drum about the benefits of non-public asset classes. The New York-listed firm has released a study, Regime Change: The Role of Private Equity in the ‘Traditional’ Portfolio. The note, as the title suggests, focuses largely on the presumed benefits of adding private equity exposure to a diversified portfolio, including comparisons with the traditional 60/40 model and KKR’s original 40/30/30 benchmark (40 per cent stocks, 30 per cent bonds, and 30 per cent in “alternatives such as private credit, real estate, and infrastructure.”
The report says that “in almost all instances, adding private equity exposure to a diversified portfolio not only boosts absolute returns but also helps deliver better risk-adjusted returns, especially for investors who are concerned about inflation.”
“From our perch, private equity makes a lot of sense for buy and hold investors, especially retirement focused investors who want to compound capital at more efficient tax rates than many income oriented products provide. We also believe that, if our team is right in our assumptions about lower forward returns across capital markets, the value of the illiquidity premium, especially in private equity, will become more important,” the report’s authors say.
There are several conclusions to draw about reports such as this. One is that advisors must continue to educate themselves and clients about the benefits of such investment – and the risks and challenges.
Another is that regulators and legislators (assuming that today’s politicians understand the issues) must craft structures that give exposure to these investments, without surrendering some protections. In this case, providers should tell people that liquidity comes at a price. As Milton Friedman liked to note, there's no such thing as a free lunch. And finally, the media world that I inhabit must do a better job of reporting on this sector.
I note from my personal experience that more journalists are branching out from covering listed stocks to covering these areas. But the mainstream media still, in my view, gives more coverage than it arguably should to the ups and downs of the Dow Jones Industrial Average etc than to private markets. I suspect that’s because it is easier to talk about an index. Covering private markets is more labor-intensive. But maybe in this age of Artificial Intelligence and the like, tools are multiplying to make it easier for us newshounds to go after value-added stories. So on that note, I hope the coverage adjusts to reflect the realities.
As ever, if you have comments, grouches or suggestions, email me at email@example.com