Just take a look at Apple (went public in 1980 at $1.8bn and is now worth $2.66tn), Amazon (went public in 1997 at $600mn and is now worth $1.54tn), Google (went public in 2004 at $29bn and is now worth $1.75tn) and Facebook (went public in 2012 at $100bn and is now worth $594bn). Yes, these are extreme examples, but the general premise was the same.

These days, it’s unfortunately not as easy. There has been a major shift in the way companies are accessing capital.  Public markets used to be the easiest and most obvious source of capital for companies to generate growth.  Now, companies are happy to access private capital and why wouldn’t they?  With large amounts of dry powder available in the market, they can raise larger amounts more easily.  Furthermore, by raising capital in private markets, they limit the loss of ownership, and they avoid the hassle and costs associated with an IPO.  There was a brief period where it looked like SPACs (Special Purpose Acquisition Companies) were the answer, but that quickly faded.

As a result, companies are choosing to stay private for longer.  Looking back at our earlier examples, Apple listed as a four-year old company, Amazon was three, Google six and Facebook eight when they went public.  These days, it is rare that companies go public this quickly.  Instead, they delay their IPOs to maximise their valuation whilst in private ownership.  In doing so, most of the returns available with these companies are generated while privately owned.  When they do eventually decide to go public, these companies are older, more mature and slower growing.  This limits the upside potential offered to investors.

An important example is Uber.  The company, which was founded in 2009 seemed to generate a lot of its value for private investors.  Uber IPO’ed in 2019 when it was 10 years old.  By this point, a lot of the return potential had already been generated and, while there had been other bumps in the road for Uber, the company’s share price has actually declined by 16% since its IPO.  This is not the only example.  A few others are Twitter (down 16%), Beyond Meat (down 34%) and, more recently, Riskified (down 75%) and Bright Health Group (down 80%) since their respective IPOs.

Not only are companies delaying their IPOs, but it seems that a number of companies are not looking to go public at all.  Through the 1980s and 1990s the number of publicly listed companies grew steadily, but this began to level off in the 2000s.  Since 2014, the global number has actually been falling.  This is more pronounced in the US, where the private equity market is the most mature, but the picture is similar in Europe.  In fact, in both regions, the number of companies listed declined by over 2% per annum from a peak of 16,500 in 2011 to just over 11,000 listed companies in 2020 (The World Bank).

What’s this all mean for investors?

Well, the truth is that it means public markets aren’t as attractive as they once were. The composition of companies that are listed are older and more mature hence provide less opportunities for higher returns.  Also, the high-growth companies where attractive returns could be made are looking to stay private for longer, so public investors lose the ability to diversify into this segment of the market. Lower potential returns and lesser diversification is what you get and this is something we expect to continue.  If you do want to make those higher returns, then private companies are where capital must be put to work.

The problem? It’s not so easy for retail investors to access private markets.  Even smaller institutional investors may struggle. The high minimums (generally upwards of $5mn), the complexity (a greater amount of due diligence and operational work) and, most importantly of all, the illiquidity (capital is usually locked up for 7+ years) meant that many investors could simply not access the asset class.  However, more recently, asset managers have begun to recognise this. You have started to see innovative solutions that can provide investors access to private markets that they previously wouldn’t have been able to allocate to.

Easier access to private companies

There are two such solutions which allow investors easy access to private companies. The first is the more traditional route (and what investors have been doing for years) – listed vehicles such as investment trusts.  The second route is to invest in private evergreen funds (as opposed to closed-ended funds), which allow for liquidity through monthly or quarterly subscriptions and redemptions.

Investment trusts are those which are listed and trade on a stock exchange, and hence offer daily liquidity.  Investment trusts are vehicles that own other investments.  A private equity investment trust would therefore hold private equity funds.  The key problem with this model is market risk.  Because they are listed, they are likely to be highly correlated to global equity markets, particularly in the short-term. Moreover, because the value of an investment trust is determined by supply and demand dynamics, it can trade at a significant premium or discount to its underlying value. Last but not least, these trusts have the ability to use gearing to invest, which increases the product’s risk profile.

The main benefit these structures offer (asides from daily liquidity) is the source of the liquidity provided. When investors want to redeem, the capital comes from the sale of their shares.  As a result, there is no pressure for the trust to force-sell any assets. Investment trusts are therefore likely to be more fully invested than evergreen structures.

For the liquid, evergreen vehicles (of which we have come across a handful), the fund takes in commitments monthly/quarterly and must be able to deploy this capital efficiently; otherwise there will be a cash drag on performance. To ensure capital is deployed efficiently, due diligence must be carried out.

One of the most important issues facing these managers is the ability to meet redemption requirements. Unfortunately, many investors have been burned by such issues in the past.  That is why thorough due diligence must be carried out to determine how fund managers meet liquidity requirements.

There are three main ways a fund can provide this liquidity. It can either hold cash (although this can increase the cash drag), it can hold liquid assets that are easily liquidated if required (although that may add to volatility), or the investment manager may choose to actively manage the duration of the underlying portfolio and/or the yield on the assets held.  It is also worth noting that these types of investment managers often have redemption limits and gate restrictions.

Final thoughts

There is clearly a trend of companies wanting to stay private for longer. They are delaying their listings for various reasons, or they may not want to list at all. This is reducing the upside potential for many listed companies, as much of the value is created whilst in private ownership. This suggests that investing in companies while they are still in the private stages of their lifecycle is more lucrative.

It is not as difficult to invest in private companies as it used to be. The problems of high minimums, complexity and illiquidity have been solved. There are structures that allow all types of investors to access private companies.  This is through either investment trusts or liquid, evergreen vehicles. We prefer liquid, evergreen vehicles, of which we have come across a handful, as they don’t exhibit the high correlations and volatility that investment trusts do. However, the necessary due diligence must be carried out to ensure that they have the right liquidity management tools in place and to ensure that appropriate redemption mechanisms have been structured.

Chirag Jasani

11 March 2022