Today, a broad structural shift is underway, with the private equity market becoming larger, more diverse and more available to companies and investors than ever before.
Driven by lower costs, less regulation, increased availability of private capital and more flexibility to focus on longer-term growth, corporations are increasingly choosing to forgo public listings. Additionally, given the large consolidation of banks and investment managers, the minimum size of a viable and attractive public deal (which includes both equity and debt) has grown over the years.
As such, the private equity market has increasingly displaced the stock market as the go-to means of financing and accessing the full U.S. economy.
Takeaway #1
Investors indexing their equity exposure are capturing only a tiny, increasingly top-heavy fraction of companies in the U.S. economy.
The opportunity set within public markets is not what it used to be. The number of U.S. publicly traded companies peaked at 8,134 in 1996 and has dropped by nearly half to 4,265 (including to OTC listings).1
The Wilshire 5000 index, which used to be synonymous with the total U.S. stock market, today has only about 3,600 holdings.2
Meanwhile, public equity indices are becoming increasingly top-heavy. Today, the ten largest constituents in the S&P 500 account for approximately one-third of the entire index. And they’re nearly all technology companies. So, the diversification benefit of “buying the index” has eroded significantly.
Now compare that to the more than 17,000 large private companies in the United States and approximately 197,000 midsize private companies in the U.S.—companies that are accessed through private equity.3
Midsize businesses account for approximately one-third of employment and one-third of output of the U.S. economy. If these companies were their own country, they would be roughly the size of Germany or Japan.4
Takeaway #2
For investors seeking attractive and durable equity performance in all types of market conditions, private equity has historically demonstrated superior results.
As investors, it always comes back to return and risk. Here, we believe private equity has demonstrated its superiority over its public market peers. While there are several types of private equity, we focus here on Buyout, which is the largest and most mature segment.
Historically superior risk-adjusted returns, with higher net returns and less realized volatility
A history of better downside protection, with smaller declines and faster recoveries
We believe much of this was driven by fundamentals. For example, during COVID-19, the predominantly private middle-market segment saw revenues decline only one percent versus six percent for the S&P 500. Similarly, employment was down only two percent for these companies versus eight percent for the S&P 500.6
History has shown us the superior risk-adjusted return profile of private equity relative to public equity. But can we trust that these dynamics will last? We believe yes.
Takeaway #3
We believe that the strong incentives embedded in private companies create a powerful and sustainable alignment of interests for institutional and private investors alike.
The three-decade shift toward the private markets has been driven by real, structural benefits to companies in remaining private. Many of these benefits have to do with incentives and alignment of interests that are likely to continue driving these trends. These benefits are typically grouped under four categories:
| Private companies | Public companies | ||
|---|---|---|---|
| Incentives and alignment of interests | Executive compensation | • Typically aligned with successful exit of private equity sponsor • Tied to growth in revenue and better operational efficiency over the next 5-7 years | • Aligned with market cap (e.g., public market CEO pay is highly correlated to the size of the company) • Tied to growth in company size and share price over the next 12 months |
| Board membership | • Typically have significant personal investment • Typically sit on fewer boards • Limited personal liability for regulatory compliance | • Often flat $ compensation • Typically sit on many boards at a time • Personally liable for regulatory compliance | |
| Board structure | • Frequent meetings (~12x/year) • Prioritize previous industry and company experience and contribution to value creation | • Infrequent meetings (~4x/year) • Prioritize independence, leading to lack of industry expertise and inability to drive value creation | |
| Regulation & oversight | • Lower cost of compliance due to fewer regulations • Long-term value often prioritized over short-term accounting profits | • Executive board structure influenced by industry regulation • Short-term accounting profits often prioritized over long-term value | |
The structure of private companies allows them to focus on longer timeframes and innovative growth, with aligned boards answering to owners (the investors) rather than “The Street.” These longer timeframes also tend to align with the longer timeframes of most institutional and individual investors.
Taken together, we believe these reasons create an equal if not stronger long-term value proposition for private equity relative to public equity. This has historically manifested itself in superior risk-adjusted returns that we believe will continue to persist and grow.
Conclusion
We expect that private equity will play an increasingly large and important role for both business owners and investors.
Today, investors have much greater means of investing in private markets than ever before. While institutional investors have invested in the private markets extensively for decades, more and more investment firms are now providing the same access for individuals.
Financial advisors can now incorporate private equity and other private market asset classes into client portfolios—providing fuller access to the broad American economy while tapping into their structural resilience and potential growth.
Individual investors are likely to continue hearing about private markets for a long time to come.
