Private Equity

Harnessing the Growth of Private Markets

Summary

  • Private equity funds offer traditional public equity market investors a means to dramatically expand their investment opportunity set and the potential to boost the growth profile of their portfolios.
  • These funds are, however, far less liquid than traditional mutual funds and ETFs. The process to acquire, improve, and exit private companies takes time, and these businesses do not trade publicly. To capture the benefits, investors need a long-time horizon.
  • Although there is a broad range of managers and strategies available, investors may face challenges accessing and evaluating the best options to meet their needs. Working with a scaled global asset manager that has institutional experience in these fields can help investors build a high-quality private equity allocation with institutional caliber governance and oversight.

Expanding investment opportunities

Private equity funds offer traditional public equity market investors a means to significantly expand their investment opportunity set and boost the growth profile of their portfolios.

Investing in private equity has grown in relevance over the past couple of decades as the public markets have become more concentrated and as the total number of listed companies in the US has come down by approximately 40% (Fig. 1 LHS). Meanwhile, the number of companies held within private equity funds in the US has increased ten-fold and now outnumber public companies by nearly 10 to 1 (Fig. 1 RHS).

Figure 1. LHS: Number of U.S. listed companies, RHS: Number of private equity owned companies

Chart illustrating the number of U.S. listed companies between 1975 and 2022. In 1975 there were less than 3,000 listed companies. The number peaked in 1996 at over 8,000 listed companies. In 2022 there was under 5,000 listed companies.
Chart illustrating the number of private equity owned companies between 2000 and 2021. The number has grown steadily from just over 5,000 private equity owned companies in 2000 to over 50,000 private equity owned companies in 2021.

The demand for private equity capital solutions has grown from businesses who prefer to remain private, and work with a smaller number of active shareholders. The supply of capital from private equity investors (initially from large institutions and now from individual investors) has also increased to meet this demand, in large part encouraged by the attractive returns the private markets have provided (Fig. 2). 

Figure 2. Price volatility and return statistics

Table with return and volatility stats measured between January 1, 2006 to March 31, 2024 for the MSCI World Index representing global equities, MSCI World Small Cap Index representing global small capitalization equities, and Preqin Private Equity Index representing private equities. The MSCI World Index experienced a return of 9.3% with volatility of 13.2%. The MSCI World Small Cap Index experienced a return of 8.6% with volatility of 16.8%. The Preqin Private Equity Index experienced a return of 13.3% with volatility of 7.8%. The return premium private equity achieves over global small capitalization equities during this time frame was 4.7%.
Chart illustrating how private credit, as represented by the Preqin Private Credit Index, has outperformed high yield bonds, as represented by the Bloomberg U.S. Corporate High Yield Bond Index, and broadly syndicated bonds, as represented by the Morningstar LSTA U.S. LL Index. Between January 1, 2006 to March 31, 2024, private credit returned 8.6% with 7.5% volatility. High yield bonds returned 6.3% with 12% volatility. Broadly syndicated bonds returned 4.7% with 9.5% volatility. Figures are in Canadian dollars and currency hedged. During this time frame, the return premium is 3.9%.

Private equity funds pool investor capital into strategies that acquire, improve, and sell private companies in the pursuit of capital gains. Historically, private equity funds have  on average outperformed public equities by more than 5% with less price volatility. Private equity is typically a high growth investment that generally does not distribute regular income.

The higher returns versus public equity strategies are attributable to the much larger opportunity set that private equity managers have to work with (Fig. 3), the market inefficiencies and informational advantages that private investors can exploit, and the numerous ways to add value to, or even completely transform, a company as an active majority owner. These companies are also often at an earlier stage in their development relative to those that have undergone the IPO process and therefore have more room for earnings growth. Private businesses operating in rapidly growing parts of the market, like technology and healthcare, may have particularly long runways of growth potential ahead of them.

Figure 3. Opportunity set of public vs. private companies

Graphic illustrating the difference in quantity of public companies relative to private companies. In the U.S. there are approximately 4,500 public companies and approximately 103,000 private companies. In Europe, there are approximately 4,300 public companies and approximately 262,000 private companies.

The methodologies used to value private assets are generally less susceptible to short term swings in market sentiment that can drive higher price volatility in publicly traded assets. Private assets are valued much less frequently than their public equivalents, and often with a considerable lag.

Fundamental differences in the investment process combined with longer time horizons required to harvest the benefits of private market investments are all factors that contribute to an “illiquidity premium” investors in these strategies have generally earned in the past and continue to expect in the future.

Key takeaway

 

Historically, the average private equity fund has outperformed the public market equivalent by ~5% and with less price volatility.

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