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Private Markets vs. Public Markets:  The case for adding Private Investments Thumbnail

Private Markets vs. Public Markets: The case for adding Private Investments

Financial advisors have been using Modern Portfolio Theory since the 90's, which one of it's tenets is to diversify across asset classes and risk profiles. This is where the historical 60/40 portfolio came in handy of providing that needed diversity. Like everything else in life, that has evolved and changed over time too. Picking up the morning paper to see where markets closed the day before is a thing of the past. But something else is different too, there's less companies in those markets and the ones that come to the public markets are coming at much later dates.

Private Markets are a Much Larger Investable Universe

Currently, there are only 2,600 public companies with annual revenues of more than $100 million, compared with 17,000 private businesses of that size.1 By this measure, investors allocating only to public equities are limiting their opportunity set to just 15% of the largest firms in the U.S. 

And the number of public companies is dwindling, shrinking from 7,810 at the beginning of 2000, to 4,814 at the end of 2020.2 Another issue is that companies are staying private longer and, in turn, have the potential to experience more of their growth and innovation before going public. For instance, in the technology sector, the average age of a new public company has gone from 4.5 years in 1999 to more than 12 years today.3 As tangible examples, two of the 10 largest-ever tech IPOs waited 10 and 12 years, respectively, before going public, long after they had disrupted the industries in which they operate.

The indices that invest in them are also becoming more top-heavy. Within large-cap indices, an enormous amount of market cap has become concentrated in a small number of firms. Just five stocks account for about one-fifth of the S&P 500 index, as of 3/31/21. For investors allocating solely to public equities, this further limits their exposure to the broader corporate universe. Going back to modern portfolio theory, if I only have 15% of available companies in my portfolio, and the number of public companies is shrinking, and I miss the biggest returns in a company, how diversified am I really.

Non-Correlated Performance

Private markets also provide a bit more diverse universe beyond just equities. Private credit, Private real estate, Hedge funds, and other niche investments are further ways to provide non-correlated returns to an investment portfolio. But perhaps the most straightforward reason private markets make sense, PERFORMANCE. Here, the statistics speak for themselves. Over the past three years, private equity has generated a premium of 38% over public equities. One dollar invested in the private markets in 2018 would be worth $1.96 today, compared with just $1.42 for a dollar invested in public equities. Private real estate and private credit have also performed quite well compared with public equities when you consider their different risk profiles. More impressive yet is the consistency of outperformance: Private equity and private credit have each outperformed global public equity and credit markets, respectively, in 19 of the last 20 years. One could argue that after a protracted period of outperformance, perhaps the tables are due to turn, and favor public equities. But here’s what’s interesting: Relative to history, it’s the public equity market where performance has been most stretched(although the recent public market downturn has brought down future P/E into more historical norms).

Do Private Investments work for you?

Rather than viewing private and public as two different strategies, both styles can and should work together to help your portfolio become more diversified. All investment theories and styles have their pros and cons, so determining which methods works best for your financial plan is key.

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  1. Capital IQ, as of February 2021
  2. Research by Professor Jay R. Ritter, University of Florida
  3. https://www.skadden.com/insights/publications/2020/01/2020-insights/private-pre-ipo-investments

This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.