What to do about the shift from public to private markets

Throughout most of the 20th century, public capital markets have provided the fuel for tremendous economic growth, job creation, innovation and personal wealth-building. Access to a large, liquid pool of capital has enabled companies to finance their growth in a cost-effective manner, thus enabling management teams to invest in new products and technologies, create millions of jobs, and attain a company’s full potential.

The lure of an initial public offering, and the potential for future gains, has attracted employees to start-up ventures that otherwise might be starved for talent. And investing in publicly traded assets has been an exceptional source of wealth-accumulation for individuals and families, notably through their pension funds.

More recently, concerns have been raised that corporations and investors may be bypassing public markets in favour of raising funds via private equity, late-stage venture capital or direct lending. Consider that the number of domestic companies listed on US exchanges, which from a peak of some 7,500 in 1996 has since declined by nearly 40%, as shown below – precipitous, despite there being some signs of recently renewed growth.

The clear increase in market capitalization in recent years is driven by a relatively small subset of big firms in the technology space, further increasing concerns of concentration. Relatedly, private market assets under management globally (including private equity, venture capital, real estate, private debt and infrastructure) rose to $6.5 trillion in 2019, the highest level on record.

As a number of corporate leaders and academic experts have pointed out, if companies continue to raise money through private mechanisms, there are consequences for the democratization of capitalism and wealth creation. As the Global Future Council on Investing, we cannot ignore this important topic.

There are, to be sure, strong arguments in favour of private capital. It enables companies to finance their growth without the pressures of quarter-to-quarter “short termism” that can plague publicly traded companies. It also has been suggested that “agency costs” may be reduced for private companies, as the interests of managements and investors are closely aligned. However, a further contraction of public markets would entail some risks:

The purpose of this post is not to suggest that public markets are inherently better than private markets, but rather that there are advantages to both types of capital. There are a number of possible solutions that can be explored to ensure that the benefits of public markets – such as investor access and transparency – are not completely lost for private markets.

1. Democratize private markets. Since there currently is no viable way for most retail investors to participate in private financings, large public institutional investors could provide a near-term solution by issuing securities backed by private market assets in their portfolios. Such private asset-backed securities might have limited liquidity (i.e. sellable only at the end of a quarter). For institutional investors, we already observe a strong increase in secondary markets for private equity which could form a first step towards making those instruments more liquid.

The US guidance for the inclusion of illiquid investments, such as private equity, into retail pension plans is another encouraging development. A longer-term solution could be to develop exchange-traded funds (ETFs) tied to private market debt or equity. Finally, the recent increase in SPAC issuance creates a bridge between public and private markets, in theory combining the depth of public markets with the specialist ownership usually seen in private markets – while it remains to be seen whether volumes are sustainable, it is certainly an interesting development. As with all forms of innovation, pragmatic and sensible regulation to protect the interests of retail investors will be a necessary support mechanism.

2. Foster public company-like discipline. Investors should play active roles in fostering good governance policies and practices on the part of the private companies in their portfolios. This is already being pursued by many private market investors, who realize that good governance is a clear avenue for value creation. Also, long-term investment and engagement might be increased through a system in which voting rights per share were linked to the share-holding period.

3. Instil a sustainability mindset. Environmental, social and corporate governance (ESG) issues have become more important to investors in public companies. Asset owners should adopt a similar focus on ESG, and consider including sustainability metrics in their evaluation and selection of private market general partners. The recent initiatives in this regard by the World Economic Forum and ILPA are encouraging.

From Ford and IBM, to Apple and Google, companies have looked to the public markets to fund innovation, growth and jobs – while investors have reaped the benefits of participating in public ownership. We do not believe public markets are going away. But we do think that private markets would be better for adopting some of the principles of inclusiveness, transparency and discipline that have long been qualities of the public markets.

This is part of a series authored by current and former members of the Global Future Council on Investing.