Are we witnessing a new era or is the talk about expanding access to private markets just a fad?
Across the globe, investors look to their public market indices to provide an indicator of potential economic growth. Stock markets provide a near-daily scoring of global economies and act as a barometer for investor sentiment. Investing in public markets is also the main tool for individuals to build wealth, save for retirement, and build financial success. However, the global public equity markets are only a part, albeit an important one, of the investment universe. In its shadows exists an equally important and large universe of private equity that for decades has been closed to most investors.
Private Securities Regulation is Evolving
Recent regulatory changes have begun to blur the boundary between public equity and private equity markets. With little fanfare and largely unnoticed, private equity investments are becoming more accessible to ordinary investors. This introduces a host of new challenges and exciting opportunities for many investors, asset managers, and other private market participants.
Private equity (PE) is a distinct form of investing that has historically delivered long-term attractive returns to its investors. PE investing often combines hands-on management and sophisticated financial engineering in order to create value for investors by enabling the management teams of portfolio companies to focus on long-term growth and performance improvement, away from the pressures of public markets and short-term volatility.
The attractiveness of PE investment returns has resulted in strong growth in assets under management for this asset class. “Investors have poured more than $2 trillion into buyout funds over the past decade for a simple reason: They deliver.” According to a recent study by Bain & Company, “Over the past 30 years, US buyouts have generated average net returns of 13.1% compared with 8.1% for an alternative private-market performance benchmark, based on the Long-Nickels public market equivalent (PME) method and using the S&P 500 as the proxy.”
Private equity has occupied an exalted place in the minds of sophisticated investors and financial markets professionals. Titans of the industry such as Steven Schwartzman at Blackstone, David Rubenstein at Carlyle, Henry Kravitz at KKR, and other investment managers have built up their businesses around PE investments, and collectively they manage hundreds of billions of dollars for the world’s most sophisticated investors.
We should acknowledge that there is a considerable debate in the academic community whether PE returns are accurately measured and whether this asset class will continue to deliver outperformance vs. public market investments. However, this is outside of our focus. While there may be disagreements regarding private equity fund performance measurement metrics, the trend suggests that this asset class will continue to grow for the foreseeable future.
Private Equity Investments as a Part of Retirement Investing Portfolios
Since private equity has historically delivered superior returns when compared to the S&P 500, it is an attractive option for retirement planning and investing. This is partially why PE firms have traditionally found a significant number of their investors among large pension funds. However, the growth of private equity investing from pension funds also coincided with the decline in the relative importance of traditional pension funds over the past 30 years. As the responsibility for retirement saving shifts to the individual investors in the form of 401(k) and similar saving plans, regulators have been obliged to reconsider the accessibility of PE investments for a broader universe of investors.
In her recent speech Dalia Blass, Director, Division of Investment Management, SEC, highlighted the focus and attention the market regulators are placing on the evolution of private markets and expanding access to it. Taken together with SEC’s efforts to modernize private markets, it is becoming clear that the private markets will need to be more accessible for an expanding universe of investors.
The opening of the private markets and accessibility of PE investments in defined contribution retirement plans such as 401(k) and other individual retirement saving plans introduce a litany of challenges that will require careful consideration and capital investments by PE firms in an effort to modernize internal operational processes, technology, and data.
Will Private Equity Firms Adopt Necessary Changes in Order to Access Additional Capital
Is it worth it for the PE firms to invest in bringing private equity into the defined contribution and other individual retirement plans? Individual retirement account assets represent a massive pool of capital. According to the latest report by the Investment Company Institute, the largest components of retirement assets in the US were IRAs and employer-sponsored DC plans (including 401(k) plans), totaling 62% of all retirement assets or $20 trillion as of year-end 2019.
Access to this pool of capital can be an important source of growth for private equity managers for decades to come. On the other hand, the ability to efficiently allocate retirement assets to private markets could be important for individual investors seeking long-term returns. Director Blass noted that “private investments have the potential to provide stronger returns and diversification for investors, but come with both performance and liquidity risks.”
Solving these operational challenges in order to support this additional source of capital, will require broad industry cooperation and collaboration between all market participants and stakeholders. Organizations like DCALTA are taking a lead in shaping best practices and providing recommendations to governing bodies that can enable the successful integration of private equity into the retirement plans of millions of Americans.
The Necessary Technology and Infrastructure Currently Exists in the Market if Desired
What is encouraging is that technology today can make solving the operational challenges far more manageable. More widely available data makes timely performance reporting and transparency possible. The emergence of alternative asset exchanges creates better liquidity options and price discovery. As the boundaries between public and private markets infrastructure dissolve, investors stand to benefit from expanded choices and better access to investment opportunities that were previously unavailable to them.
This is an important stage in the evolution of the capital markets and private investing in particular as both will be required to support efficient global economic growth and the flow of capital for the coming decades.