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The recent growth of private markets is a phenomenon. Indeed, private funds, which include venture capital, private equity, private debt, infrastructure, commodities and real estate, now dominate financial activity. According to consultant McKinsey, assets under management in private markets reached $13.1 trillion by mid-2023 and has grown nearly 20% annually since 2018.
For many years, private markets raised more shares than public markets, where contraction due to share repurchases and repurchases was not offset by the decline in the volume of new issues. The dynamism of private markets means that companies can remain private indefinitely, without worrying about accessing capital.
One consequence is a significant increase in the proportion of the stock market and economy that is not transparent to investors, policymakers and the public. Note that disclosure requirements are largely a matter of contract rather than regulation.
Much of this growth has occurred against a backdrop of extremely low interest rates since the 2007-2008 financial crisis. McKinsey points out that about two-thirds of the total return from buyout deals entered into in 2010 or later and closed in 2021 or earlier can be attributed to broader movements in market valuation multiples and leverage, rather than to an improvement in operational efficiency.
Today, these exceptional gains are no longer available. Borrowing costs rose thanks to tighter monetary policy and private equity managers found it difficult to sell portfolio companies in a less buoyant market environment. Yet institutional investors have an ever-increasing appetite for illiquid alternative investments. And big asset managers are looking to attract wealthy retail investors to the region.
While private equity is near unprecedented levels, private equity is seen as providing greater exposure to innovation within an ownership structure that ensures greater oversight and accountability than in the listed sector. At the same time, half of funds surveyed by the Official Monetary and Financial Institutions Forum, a British think tank, said they planned to increase their exposure to private credit over the next 12 months, compared with around one quarter last year.
At the same time, politicians, particularly in the United Kingdom, are giving new impetus to this headlong rush, with a view to encouraging pension funds to invest in riskier assets, notably infrastructure. Across Europe, regulators are relaxing liquidity rules and price caps in defined contribution pension schemes.
Whether investors will benefit from a substantial illiquidity premium in these heady markets is debatable. A municipality report by asset manager Amundi and Create Research highlights high fees and charges in private markets. It also highlights the opacity of the investment process and performance evaluation, the high friction costs caused by the premature exit of portfolio companies, the high dispersion of final investment returns and a record level of dry powder – sums allocated but not invested, waiting for opportunities. arise. The report warns that massive capital inflows into alternative assets could dilute returns.
The rise of private markets raises broader economic questions. As Allison Herren Lee, former commissioner of the United States Securities and Exchange Commission, said: sharp Apart from this, private markets depend to a large extent on their ability to freely benefit from the transparency of information and prices in public markets. And as government procurement continues to shrink, so does the value of this subsidy. The opacity of private markets could also lead to misallocation of capital, according to Herren Lee.
The private equity model is also not ideal for certain types of infrastructure investments, such as the British water industry demonstrates. Lenore Palladino and Harrison Karlewicz of the University of Massachusetts argue that asset managers are the worst type of owners of an inherently long-term good or service. Indeed, they are not encouraged to sacrifice in the short term for long-term innovations or even for maintenance.
Much of the dynamic behind the move to private markets is regulatory. Tighter capital requirements on banks after the financial crisis led to lending to less regulated non-bank financial institutions. This was not a bad thing in the sense that useful new sources of credit existed for small and medium-sized businesses. But the associated risks are more difficult to track.
According to Palladino and Karlewicz, private credit funds present a unique set of potential systemic risks to the financial system as a whole due to their relationships with the regulated banking sector, the opacity of loan terms, the illiquid nature of loans and potential maturity mismatches. with the needs of limited partners (investors) to withdraw funds.
For its part, the IMF argued that rapid growth in private credit, coupled with increasing competition from banks on large transactions and pressure to deploy capital, could lead to a deterioration in pricing and non-price conditions, including a lowering of underwriting standards and a weakening of credit conditions. covenants, thereby increasing the risk of credit losses in the future. There is no reward for guessing where the next financial crisis will emerge.
