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The recent growth of private markets has been a phenomenon. Indeed, private funds, which include venture capital, private equity, private debt, infrastructure, commodities, and real estate, now dominate financial activity. According to consultants McKinsey, private markets assets are under management receipt $13.1 trillion in mid-2023 and has grown by nearly 20 percent annually since 2018.
For many years, private markets have raised larger volumes of shares than public markets, as the shrinkage resulting from share buybacks and takeover activity has not been offset by a dwindling volume of new issuances. The vitality of private markets means that companies are able to remain private indefinitely, without any concerns about access to capital.
One result is a significant increase in the proportion of the stock market and the economy that is not transparent to investors, policymakers, and the general public. Note that disclosure requirements are largely a matter of contract rather than regulation.
Much of this growth has occurred against the backdrop of very low interest rates since the 2007-2008 financial crisis. McKinsey notes that nearly two-thirds of the total return on buyouts entered into in 2010 or after and exited in 2021 or earlier can be attributed to broader movements in market valuation multiples and leverage, rather than improved operating efficiency.
Today, these windfalls are no longer available. Borrowing costs have risen thanks to monetary policy tightening, and private equity managers are having difficulty selling portfolio companies in a less buoyant market environment. However, institutional investors have a growing appetite for illiquid alternative investments. Large asset managers are seeking to attract wealthy retail investors to the region.
With public equity approaching all-time highs, private equity is seen as providing better exposure to innovation within an ownership structure that ensures greater oversight and accountability than the listed sector. Meanwhile, half of the funds surveyed by the official Monetary and Financial Institutions Forum, a UK think tank, said they expected to increase their exposure to private credit over the next 12 months – up from about a quarter last year.
Meanwhile, politicians, most prominently in the UK, are adding momentum to this headlong rush, aiming to encourage pension funds to invest in riskier assets, including infrastructure. Across Europe, regulators are relaxing liquidity rules and price caps in defined contribution pension plans.
Whether investors will reap a significant premium for illiquidity in these wild markets is debatable. subscriber a report By asset manager Amundi and Create Research highlights the high fees and expenses in private markets. It also illustrates the opacity of the investment and performance evaluation process, the high frictional costs of early exits from portfolio companies, the high dispersion in eventual investment returns, and the unprecedentedly high level of dry powder – amounts allocated but not invested, waiting for opportunities. To arise. The report warns that massive flows into alternative assets could dampen returns.
There are broader economic questions related to the prosperity of private markets. As Alison Herren Lee, former commissioner of the U.S. Securities and Exchange Commission, said He pointed out Abroad, private markets depend largely on the ability to free ride on the transparency of information and prices in public markets. As public markets continue to shrink, the value of this support also shrinks. According to Hren Lee, the opacity of private markets can also lead to misallocation of capital.
The private equity model is also not ideal for some types of infrastructure investment, as experience has shown British water industry It is clear. Lenore Paladino and Harrison Karlowicz of the University of Massachusetts argue that asset managers are the worst kind of owners of an inherently long-term good or service. This is because they have no incentive to sacrifice the short term for long-term innovations or even maintenance.
Much of the dynamic behind the shift to private markets is regulatory. Strict capital adequacy requirements imposed on banks after the financial crisis pushed lending to less regulated non-bank financial institutions. This was not a bad thing, in the sense that there were new sources of credit useful for small and medium-sized businesses. But the associated risks are difficult to track.
According to Paladino and Karlevich, private credit funds pose a unique set of potential systemic risks to the broader financial system due to their interrelationship with the regulated banking sector, the ambiguity of loan terms, the illiquid nature of the loans and potential mismatches of maturity periods. With the needs of limited partners (investors) to withdraw funds.
For its part, the International Monetary Fund said that the rapid growth of private credit, coupled with increasing competition from banks for large deals and pressures to deploy capital, may lead to a deterioration in pricing and non-pricing conditions, including lower underwriting standards and weak covenants, which increases the risks of… Future credit losses. There are no prizes for guessing where the next financial crisis might emerge from.
