With the Woes of Short-Termism, Should Investors Turn to Private Equity?

Shrinking Universe of Public Companies

The second potential cause of declining equity returns is the shrinking universe of publicly traded companies. All too aware of the constant pressure applied by public market investors and analysts to meet quarterly earnings, many leading private companies are avoiding listings altogether.

With the number of IPOs running at half the levels of the 1990s and 1980s, the number of U.S. public companies has nearly halved over the past 20 years to under 4,000, leaving a pool of generally more mature, lower growth companies.

There also is mounting research suggesting that much of the equity value in some of the world’s most successful and often disruptive businesses is being created prior to an IPO, leaving retail investors unable to participate in most of the upside.

This trend can be seen below. If your retail clients had purchased stock in Amazon’s IPO in 1997 and held it until today, they would have achieved a return of over 900 times.

By comparison, if your clients had bought into the IPOs of Alibaba, Facebook and Google (all of which stayed private much longer than Amazon did), they would have experienced much smaller returns, as private investors had already reaped the hyper growth that occurred during the private phase.

Some public companies are even delisting from exchanges to focus on long-term goals.

One high profile example is Dell, the technology giant that was taken private in 2013 after spending 25 years as a publicly traded company. Dell believed that it was unable to execute upon its long-term plans while operating under the microscope of public markets, with the company’s founder, Michael Dell, highlighting that as a private company it was “able to be bold, make investments and focus 100% on customers.”

After spending five years turning the business around and pursuing a key acquisition, Dell is now apparently worth nearly triple its valuation at the time of its buyout.

The Private Equity Solution

With continued short-termism posing a threat to the long-term return profile of public markets, it is increasingly important for your clients to find ways to gain exposure to private businesses that buck this trend.

This is where the SEC announcement about potentially loosening of the definition of “accredited” investor comes into play and is an area to watch closely.

Perhaps the biggest issue for investors looking to allocate to private equity is liquidity, as these funds typically require long lock-up periods. However, for investors truly intending to maintain long-term exposure to equities, reallocating 5%-10% of a total portfolio to private equity should have a negligible impact on overall liquidity while enhancing diversification.

In addition, one of the inherent benefits of the illiquid nature of private equity is that the investor is placing the decision of when to sell in the hands of experienced fund managers, thereby preventing individuals from selling investments at the wrong time under adverse market conditions. In other words, the private equity model forces individual investors to adopt a “buy and hold” discipline.

Fortunately, technological advancements have made private equity more accessible to qualified investors than ever before, while also streamlining the reporting and administration for their wealth advisors.

Nick Veronis is co-founder and managing partner of iCapital Network, and Dan Fletcher is director of iCapital Network.

— Related on ThinkAdvisor:

• Is Private Equity Bad for Broker-Dealers?
• Reporting Profits Daily Would End Short-Termism