April 22, 2019
Private Investments: Reassessing the Landscape
Global private investment markets are attracting record levels of investors, pushing assets under management to an all-time high of $5.2 trillion.1 Relative to public markets, this performance remains compelling to investors with long time horizons, and 46 percent of these investors plan to increase their allocation over the long term.2 With private investments experiencing a renaissance, now is an opportune time to assess the factors shaping the current landscape, debunk misconceptions about the asset class and evaluate the benefits and boundaries of private investing. In this discussion, private investments refers to venture capital, buyouts, growth capital, infrastructure and equity real estate investments not traded on public exchanges.
WHAT IS DRIVING GROWTH IN PRIVATE INVESTMENTS?
As alpha—excess investment return—becomes more elusive, investors are seeking public market alternatives. With today’s relatively high public equity valuations, rising bond yields and uncertainty about global economic and trade policies, private investments offer an attractive source of less-correlated, long-term returns while dampening short-term volatility.
In addition, the number of stocks listed on U.S. exchanges has declined 50 percent since 1996.3 Mergers and acquisitions, management buyouts, share buybacks and longer incubation periods before initial public offerings have tightened the supply of publicly traded equities. Today’s IPO rate is less than half that of the late 20th century, as disruptors like Dropbox attract tens of billions of dollars while remaining private.4 A cohort of high quality, well-run businesses may never go public.
The result is a shrinking supply of publicly traded shares, an increasing number of private investment opportunities and rising demand from institutional investors. Armed with ample and patient capital and long-term liability and capital-preservation objectives, the private ownership model offers investors a growth-oriented return premium.
DEBUNKING COMMON MYTHS
The private investment market has evolved since it first captured the media’s attention in the late 1970s, yet the asset class remains misunderstood. Four of the most persistent myths are explored below:
MYTH #1: Private investments always use leverage and cut costs for a quick profit.
Modern private investments frequently focus on long-term growth, not short-term restructuring. The typical private investment fund has a ten-year lifecycle and a four- to five-year hold time. By contrast, the average investor hold time of a public stock is now 22 seconds.5 The private investment model favors growth and value creation. Unconstrained by short-term performance goals, private investment sponsors have time to build out the companies they target. Environmental, social and governance (ESG) best practices, which decrease operational, reputational and regulatory risks, and contribute to positive long-term performance, are often integrated into their approach.
MYTH #2: Private investments are exotic and complex.
Private investments need not be exotic or complex. There are generally no derivatives or esoteric financial theories involved. The model is straightforward: invest in a business, manage and grow it over several years and sell it for a profit either privately or through a public offering. The term “exotic” is a vestige of the 20th century when non-publicly traded investments were not included in traditional asset allocation models. Today, the preferred term is “alternative,” which reflects the diversifying risk/return characteristics of private investments relative to public markets. These alternative investments are often an integral component of allocation models for institutional and individual investors.
MYTH #3: All private investments are alike.
Private investments are not limited to tech startups or distressed companies. The opportunity set is diverse in scope and deal structure. Private investments cover the full spectrum of the global economy at all stages of the business lifecycle, from mature, international companies seeking succession strategies, to movie and music rights, to U.S. shale oil technology and emerging market infrastructure ventures. The depth and breadth of private investment opportunities, many uncorrelated to public markets, offer a level of return potential and risk protection distinct from other asset classes.
MYTH #4: Private investments are always volatile.
Private investments can offer a smoother ride than the public markets, especially during volatile periods. The nature of private investments allows investors to be disciplined. Capital is committed for the long term, avoiding the market-timing risks associated with traditional equity and fixed income strategies. These investments may provide downside risk protection during chaotic market environments.
BENEFITS AND BOUNDARIES FOR INVESTORS
Private investments offer many benefits and can deliver an attractive risk/reward profile that increases diversification, is less correlated with the public markets and buffers total portfolio risk. Additionally, private investments provide an opportunity for direct participation in innovation and value creation with more management input relative to public equity ownership.
However, private investments are not appropriate for everyone and are only available to those who meet specific criteria, including substantial minimum-capital commitments and tolerance for long-term illiquidity. Investors must evaluate fund managers for risk exposures that can be difficult to control or value, and careful tax planning is necessary as participation in private investment partnerships have complex reporting and filing requirements.
GLENMEDE’S APPROACH TO PRIVATE INVESTING
Glenmede has managed private investment strategies for institutions and accredited individuals for over 25 years. Our reputation as a pedigreed partner and a reliable source of capital provides coveted access to premier sponsors and institutional-quality investment opportunities. This is particularly important in private markets, as we have observed that good managers tend to persist in their ability to deliver alpha.
As a midsized manager with a dedicated team and research capabilities, we have the critical mass required to evaluate and participate in a diverse opportunity set.
Unlike private investment mega-funds, we are not constrained by requirements to make capital investments by specific dates. Instead, we strategically invest when markets are particularly attractive. We seek growth across all sectors and geographies and believe the potential of private impact investments in developing economies is especially compelling.
THE BOTTOM LINE
Private investments can provide a less-correlated source of alpha and downside risk protection for suitable longer-term investors able to tolerate illiquidity. With global institutional investors leading the way, private investments have evolved toward a more transparent business model that favors experience, reputation and quality. As a preferred investor for premier private investment sponsors, Glenmede remains committed to an opportunistic approach that seeks growth and value creation in alignment with client objectives and risk tolerance.
1 “The Rise and Rise of Private Markets.” McKinsey & Company. McKinsey Global Private Markets Review 2018.
2 “Alternatives in 2019.” Prequin.
3 “Where Have all the U.S. Public Companies Gone?” Bloomberg Editorial Board. April 9, 2018.
5 “Dark Pools: The Rise of AI Trading Machines and the Looming Threat to Wall Street.” Scott Patterson. 2011. As cited in “The Value of Everything.” Mariana Mazzucato. 2018.
This writing is intended to be an unconstrained review of matters of possible interest to the Company’s clients and friends and is not intended as personalized investment advice. Advice is provided in light of a client’s applicable circumstances and may differ substantially from this presentation. Glenmede’s affiliate, Glenmede Investment Management LP, may conduct certain research and offer products discussed herein. Opinions or projections herein are based on information available at the time of publication and may change thereafter. Information gathered from other sources is assumed to be reliable, but accuracy is not guaranteed. Outcomes (including performance) may differ materially from expectations herein due to various risks and uncertainties. Any reference to risk management or risk control does not imply that risk can be eliminated. All investments have risk. Clients are encouraged to discuss the applicability of any matter discussed herein with their Glenmede representative. Nothing herein is intended as legal or federal tax advice.