What the rise in private equity means for your equity investments

The private equity world, already flush with cash, is looking for trillions more — this time from individual investors.

The influx could mean big changes not only for investors but also for the public stock market.

Private markets are expected to grow to about $12.5 trillion in 2025 from $7.2 trillion in 2020, according to Morgan Stanley. Buyout, growth capital and venture capital account for about 69% of the industry, the investment bank said. Private equity firms, whose funds have long been a major holding company for pension and other institutions, are racing to develop new products that appeal to wealthy people and offer them to the financial advisers who manage their money.

The efforts of these funds may accelerate another trend that has been underway for two decades, industry executives say. The number of public companies in the U.S. is already well below its peak since the late 1990s, and industry executives and market historians expect them to decline even further as widespread access to private capital gives even companies with billions of dollars to delay the IPO. Private equity firms will continue to seek buyout candidates in the public markets.

“The decline in public companies and the increase in private market participation are related,” said Tony Tutron, global head of Neuberger Berman’s NB Alternatives business, which focuses on private market investments.

Spiraling inflation, rising interest rates and fears of a recession have hit stocks this year, closing the window for most new public offerings. But even if market conditions become more favorable for IPOs in the coming years, many private companies may put off the decision for longer, industry executives say.

It is not certain that people will embrace private markets in the way that pensions and other institutions have. Many might object to the higher fees and lack of liquidity that often accompany private equity. Unlike mutual funds and ETFs, private funds impose restrictions on when investors can withdraw their money — even if future offerings aimed at individuals are less restrictive than funds traditionally sold to pension and other institutions.

Here’s what financial experts say is driving the shift in the public-private market and how it could evolve in the coming years.

PHOTO ILLUSTRATION BY: SEAN MICHAEL JONES FOR THE WALL STREET JOURNAL (2)

Where have small cap stocks gone?

One reason many investors find private equity so attractive: It gives them a chance to invest in companies that are slowly disappearing from the public market — small-cap stocks with big-cap potential.

The number of public companies in the U.S. has declined sharply in the years since the dot-com bubble burst, falling to 4,995 in 2013 from 8,872 in 1997, according to the Center for Research in Security Prices LLC. Since then, the number has hovered around 5,000 as mergers and acquisitions more or less offset new offerings.

A decade-long merger boom has made it much more likely that promising startups will end up inside titans like Microsoft corp.

or Facebook parent Meta Platforms Inc. before they went public. And those that remain independent are staying private longer, delaying their IPOs until they can debut as large-cap companies — a trend that some expect will intensify in the future. There are more than 1,100 “unicorns,” or private companies, valued at more than $1 billion as of June, according to CB Insights.

Going public also brings more scrutiny and requires more disclosure of a company’s results, Mr. Tutrone notes.

Companies once went public to fuel core parts of their operations or growth plans, said Tim Koller, a partner at McKinsey & Co. “Now it’s more about creating liquidity or being able to share it with employees,” he said.

Last year, the number of U.S. listed companies reached 5,600, CRSP said, as low interest rates helped boost the value of growth companies, both public and private, persuading some startups to go public. Others have done so through special purpose acquisition companies or blank check entities that tap the public markets with the stated intention of merging with a private company.

But with interest rates rising, stocks in a bear market and SPACs facing regulatory crackdowns, the surge in new public companies is not expected to continue. By June, the number had fallen back to 5,509, CRSP said.

“It’s fair to expect that the number of public firms is likely to decline, but at a slow pace,” said Rene Stultz, chairman of the department of banking and monetary economics at Ohio State University’s business school.


Photo illustration:

Sean Michael Jones for The Wall Street Journal

Toughest market

Large public companies are also growing. The 10 largest companies in the S&P 500 index, a list that includes Apple Inc.,

Microsoft, Amazon.com Inc.

and Meta—now account for about 30% of the benchmark’s market cap.

Until last year, the dividing line in market capitalization between the Russell 1000 index, a benchmark that tracks the largest 1,000 public companies, and the Russell 2000, which includes the next 2,000 largest, was $5.2 billion. This is more than four times more than in 2009, immediately after the financial crisis.

What’s more, the companies in the Russell 2000 now represent less than 10% of the total value of the stock market. “And half of those stocks are microcaps,” said Mark Makepeace, chief executive of Wilshire and founder of FTSE Russell, which launched the Russell indices. “Profitability is much lower and they are not what managers want to hold.”

The change made it harder for stock traders to diversify their portfolios, prompting some to turn to private equity.

“If our job is to find and invest in the best companies, but you have such a large decline in the small and mid-cap category, which is so important to us, it makes a lot of sense to look for those companies that could be public, but they’re not,” said David DiPietro, head of private equity at T. Rowe Price Group Inc.,

The 85-year-old mutual fund giant.

The new frontier of private equity

Investment firms’ traditional clients, including pension plans and sovereign wealth funds, still allocate much of their assets to private markets. But many are approaching their limit. The potential slowdown has prompted private equity firms, the largest of which are already publicly traded companies, to seek a new frontier for growth. Individual investors – whose access to private equity and debt has until now been limited to the very wealthy – fit the bill.

Black stone Inc.,

industry heavyweight, has launched private real estate and debt funds targeting individuals. And earlier this year, the firm sought permission from regulators to launch a new fund that gives individuals access to leveraged buyouts. The filing was in May and there has been no significant development since then.

These funds and others like them offer tweaks that make them more palatable to high-net-worth individuals than products traditionally marketed to institutional investors and the ultra-wealthy, including lower fees and the ability to make more frequent withdrawals.

The prospect comes with some concerns. The influx of new money into private equity could make it harder for many private equity managers to outperform the public market as they have done in recent years. As more asset managers seek to build a presence in private markets, some will invariably chase some of the same deals – driving up purchase prices and reducing their bottom line returns.

“It’s a continuous cycle we’re going through where the high entry into an asset class overwhelms the attractive investments and then, as a result, the aggregate return is not as great,” says McKinsey & Co.’s Mr. Koller.


Photo illustration:

Sean Michael Jones for The Wall Street Journal

Opaque economy

Private companies are not required to disclose as much information about their operations as publicly listed ones, making much of the economy less transparent. And some worry that the growth could eventually leave the biggest private equity firms in control of an ever-larger portion of the market.

The growth of private capital is also likely to reduce the amount of information available to the public. Although private fund investors receive regular updates on how holdings are performing, these reports may not be as reliable.

“It benefits companies in terms of developing strategies and staying off the radar,” says Mr. Stultz. “If you have to disclose to investors, you have to disclose to competitors.” But he adds, “If more and more companies are disclosing relatively little compared to public companies, that means you don’t have the insight into the economics that you would otherwise have. “

Winners take the most?

None of this spells doom for the markets. But these changes could make it more difficult for investors to diversify their portfolios. In the future, an even larger part of the investing world may be tied to two groups of giants: Mega-cap stocks, increasingly owned by a handful of massive index fund managers; and the largest private equity firms, which are expected to benefit disproportionately from the growth of their market.

“Private capital is also quite concentrated,” says Ludovic Falipou, professor of financial economics at Oxford University. “You can have a world where 20-30 companies control everything.”

Mr. Kohler disagrees, noting that large companies rarely maintain their dominance over time. Technology evolves and customer needs change. The conglomerates that were so popular with stock investors in the 1970s are gone, he says, and few, if any, of the biggest tech companies in 1990 still rank among the top 30 today.

“Economics and markets are dynamic and rarely do trends last forever,” he said.

Write to Justin Baer at justin.baer@wsj.com

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