What are the trends in public versus private markets?
Publicly traded companies include household names listed on the stock exchanges, such as Coca-Cola, Proctor and Gamble, and Apple. Given the available access to public information and the near-immediate liquidity when buying and selling shares, publicly traded companies typically make up the largest portion of individual investor portfolios.
However, the number of publicly traded companies in America continues to decrease. In fact, of domestic companies with corporate revenues of $250 million or more, 86% are private while only 14% are public.[1] This shift may be reflective of regulatory changes and access to capital. Specifically, in the post-Great Depression era, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934, which forced companies who wanted to scale to disclose financial information publicly to increase transparency. At the time, private investments were limited to 100 distinct investors, which limited the growth trajectory of these companies.[2] Therefore, businesses desiring to raise significant capital were forced to follow the reporting and disclosure requirements of the SEC. A shift occurred with the passing of the National Securities Market Improvement Act in 1996, which allowed private investments to raise unlimited capital from an unlimited number of distinct investors.[3] At the peak in 1996, there were approximately 7,300 publicly traded companies in the U.S. Today, there are approximately 4,300.[4] America doesn’t have fewer companies than it did three decades ago. Instead, they are simply increasingly choosing to remain private.
In conjunction with this regulatory shift, the number of private equity firms has increased significantly over time. Specifically, the number of U.S. companies backed by private equity has grown from 1,900 to 11,200 over the last two decades.[5] Private equity companies can provide access to capital and business guidance without the regulatory burdens associated with public markets.
Due to the structure of traditional private investments, however, these investments have largely been limited to institutional investors, such as pension funds and endowments, as well as ultra-high-net-worth individuals (Daddy Warbucks). Accordingly, private investments consist of approximately 57% of endowment portfolios, 23% of public pension portfolios, and only <3% of average individual investor portfolios.[6]
Why would individual investors potentially find private markets desirable?
Stocks and bonds have historically been regarded as the primary tenants of diversified portfolios for individual investors. Traditionally, when stocks rose in value, bonds decreased in value and vice versa. In recent economic cycles, however, this relationship has become somewhat distorted, resulting in higher correlated returns (and losses).
If individual investors could incorporate private investments with their public stocks and fixed income, there may be an opportunity to mitigate volatility due to the difference in the underlying risk factors. Further, the expected returns in the private markets may exceed those of the public markets, depending on the investment. However, nearly all private investments offer less liquidity than public investments. Accordingly, for investors willing to give up some liquidity, there may be an opportunity to decrease volatility and increase expected returns if private investments are included as a complement to the traditional stock and bond portfolio. Below is a summary of some key opportunities within the private markets.
- Private real estate – Real estate has been viewed as an effective inflation hedge. Unlike bonds, which typically pay a fixed interest payment, real estate portfolios have the flexibility to increase rents over time and the potential to sell the asset at a premium (or loss).
- Private credit – Private debt markets can structure debt more advantageously to earn the desired return at a desired risk level. Borrowers in the private markets gain quick access to capital with limited regulatory burdens. In exchange for this convenience, private borrowers may be willing to agree to terms more favorable to the lender, such as floating-rate loans. Additionally, lenders can push for seniority in the capital structure to promote repayment in the case of a default. Further, some firms offering private credit solutions also have a full private equity portfolio. Therefore, these firms can offer favorable pricing for items such as office supplies, shipping, and technology solutions because the vendors are part of their portfolio.
- Private equity – Private equity companies invest resources in private companies. They typically operate on a longer-term time horizon with the goal of improving operational efficiencies to create additional value.
The unique characteristics of private market assets have the potential to create uncorrelated performance relative to public markets. This dynamic promotes portfolio diversification, reduces volatility, and increases potential expected returns for those investors willing to give up the liquidity.
Why are investment firms shifting attention to individual investors and what are they doing to attract them?
Individual investors with a liquid net worth of $1 million or more account for an estimated $80 trillion of investor wealth globally.[7] This $80 trillion opportunity has caught the attention of investment management firms and has encouraged them to tailor their investment offering to be more suitable for individual investors.
Below are some of the key characteristics now offered by management firms designed to specifically attract individual investors:
- Lower minimum investments – minimum investment requirements now range from several thousand dollars as opposed to historical levels potentially ranging in the several million dollars
- Frequency of redemptions – monthly or quarterly redemptions are increasingly popular as opposed to the traditional 7 to 10 plus year lock-up period
- Simplified tax reporting – many funds report on a simple 1099 as opposed to a K-1
- Perpetual fund structure – Investors are now able to fully invest the desired capital on day one as opposed to the deployment lag that is present in a standard draw-down fund.
Through these improvements to investment fund structures, private assets are becoming increasingly accessible to everyday individual investors.
Are private investments appropriate for everyone?
Absolutely not. Most private investments limit participation to accredited investors. An “accredited investor” is a term defined by the SEC, noting “Individuals (i.e., natural persons) may qualify as accredited investors based on wealth and income thresholds, as well as other measures of financial sophistication.” The specific financial criteria are defined below. Please refer to the SEC website for a complete list of Professional Criteria.[8]
Financial Criteria:
- Net worth over $1 million, excluding primary residence (individually or with spouse or partner)
- Income over $200,000 (individually) or $300,000 (with spouse or partner) in each of the prior two years, and reasonably expects the same for the current year
Private investments have different risk profiles from public investments. First, there is a lack of transparency as private companies have significantly fewer disclosure requirements than their public counterparts. Therefore, individual investors should not participate in private funds without proper education of the underlying risk characteristics. Secondly, as previously discussed, private investments introduce liquidity risk as funds are not immediately available for sale and redemption as are public funds. Careful consideration of investors’ financial sophistication, liquidity needs, and personal goals is required when determining whether incorporating private investments is appropriate.
Conclusion
This is an exciting time for sophisticated individual investors to consider including private investments in their portfolios. Given their nature, the returns are typically less correlated with public markets and may contribute to a higher return. Accordingly, through investing in private investments, individual investors may have the opportunity to decrease volatility risk by increasing liquidity risk. The recent efforts of asset managers to increase the accessibility of private investments to individual investors through lower minimum investments, more frequent redemptions, and simplified tax reporting help make the investment process more convenient and transparent. Individual investors now have the potential to benefit from opportunities historically only afforded to institutions and ultra-high-net-worth investors. As part of your overall wealth management plan, we may discuss the possibility of incorporating private investments into your plan. If you have questions about these investments, please do not hesitate to contact us.
[1]https://pws.blackstone.com/essentials-of-private-equity/
[2]https://www.theatlantic.com/ideas/archive/2023/10/private-equity-publicly-traded-companies/675788/
[3]https://www.theatlantic.com/ideas/archive/2023/10/private-equity-publicly-traded-companies/675788/
[4]https://www.cnn.com/2024/04/09/investing/premarket-stocks-trading/index.html
[5]https://www.cnn.com/2024/04/09/investing/premarket-stocks-trading/index.html
[6]https://pws.blackstone.com/essentials-of-private-markets/
[7]Blackstone’s Gray: Product design key to unlocking $80trn individual investor opportunity (privateequityinternational.com)
[8]https://www.sec.gov/resources-small-businesses/capital-raising-building-blocks/accredited-investors