The writer is editor-in-chief of MoneyWeek
When Jeff Bezos took Amazon public in 1997, the company was three years old. He needed $50m and the public markets were the only place to get it.
This week, ecommerce firm The Hut Group announced plans to list in the UK. The company is 14 years old. It is looking to raise just over $1bn. But the reason for its listing is not raising cash: it has instead been prompted by a “request for liquidity” from backers. Those backers? Private equity features heavily: KKR owns 19 per cent of the business.
These two listings tell the story of the past 20 years. According to a report from Morgan Stanley, companies have raised more money in private markets than public in the US every year since 2009 — Twitter raised $800m privately before listing in 2013 for example. Companies are listing much more rarely and much later — often after their growth years have been financed by private equity. The average age of a 1990s firm at listing in the US was 8. Now it’s 11.
It is obvious that this matters. As Duncan Lamont at Schroders, the fund asset manager, says, “public equity markets represent the cheapest and most accessible way savers can participate in the growth of the corporate sector”. If they are allowed to wither, ordinary investors miss out — all the more so given that non-listers are often in high-growth industries. Over time if the best companies don’t list, returns from public markets are likely to fall. If you had invested $10,000 in Amazon in 1997 you’d have $12m now. Sure, Amazon is an outlier, but small growth companies come with potential for extreme gain. It would be brave to suggest the more mature Hut offers the same. There are implications here for wealth inequality and (if too much growth accrues too obviously off-market to too few) for public acceptance of capitalism.
What has been driving the shift off-market? It is partly a matter of companies being reluctant suppliers. The cost of listing has risen hugely since the 1990s. One example: the number of pages in the median annual report is up to 50,000 from 23,000. So has public scrutiny of executives. It’s not as easy, low cost or indeed as fun as it used to be to run a listed company.
However the real explanation might be not on the supply side but on the demand side. The simplest explanation of the extraordinary shift, says Morgan Stanley is the “demands of institutional investors”. If you run a pension fund you are likely to be fretting about the yawning gap between assets and liabilities. In the US, unfunded pension liabilities could run as high as $6tn. In the UK the Pension Protection Fund notes a total deficit for defined benefit pension schemes of £200bn.
There are three things managers can do about these horrors. They can pay less out to beneficiaries (no one is keen on this); pay more into the plan (sponsoring companies aren’t keen on this) or finally, try and up the return on the assets they do have. Everyone likes this option, but that’s not as easy as it was.
Just look at the history of the $350bn held by the California Public Employees’ Retirement System. Until the early 1990s, managers assumed they would hit a rate of return on those assets that was below the yield on Treasuries. That made things easy (buy bonds, go home). By 1992, the assumed return rate was 8.75 per cent and the yield on a 30-year treasury bond was 7.75 per cent. That wasn’t so easy, but managers only needed to find another 1 per cent a year. Earlier this year, the numbers were 7 per cent and 1.4 per cent respectively. You see the problem. Calpers has no choice — or feels that it has no choice — but to look for higher returns. That might have once meant putting more money in listed equity. It doesn’t any more: GMO forecasts falls of 4-6 per cent in US equities over the next seven years. That drives managers to private equity.
This is not a dynamic that is going to change soon. Private equity resources are at record highs. And there is more coming. One of the world’s largest single investors, California State Teachers’ Retirement System recently raised its allocation to private equity from 9.4 per cent to 13 per cent. Nearly half of institutional investors recently surveyed by BlackRock said they were looking for more private equity. The US has also just made it easier for individuals to invest in private equity via their retirement plans.
Is this a good idea? The jury is out. There is evidence that historical returns have been higher in private equity, and less volatile too. But the latter trend may simply reflect the fact that private equity managers can use illiquidity to smooth returns, while the former may not survive the rapid growth of the industry — which has bumped up competition for, and prices of, private companies (bubble alert).
Ordinary investors might be tempted to ignore the whole thing and look to make old-fashioned equity returns from newer markets. The number of listed companies may have fallen in the US, UK and Germany but it has risen significantly elsewhere — in Asian markets for example. Sadly that won’t be enough. The best companies everywhere will probably remain in private hands for some time. For the world’s investors, the promise of a debt-fuelled something in private equity is better than the certainty of almost nothing elsewhere.