What private equity growth 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 equity markets are expected to grow to about $12.5 trillion in 2025 from $7.2 trillion in 2020, according to Morgan Stanley. Buyouts, growth capital and venture capital make up about 69% of the industry, the investment bank said. Private equity firms, whose funds have long been a staple of pensions and other institutions, are racing to develop new products that will appeal to wealthy individuals and market them to financial advisers who manage their money.

The funds’ efforts could accelerate another trend that has been underway for two decades, industry executives say. The number of U.S. public companies, now well below their peak in the late 1990s, and industry executives and market historians expect them to shrink further, as widespread access to private capital gives even multibillion-dollar firms reason to push. public appearance. And private equity firms will continue to scour the public markets for takeover candidates.

“The decline of public companies and the rise of participation in private markets are linked,” says Tony Tutrone, global head of Neuberger Berman’s NB Alternatives business, which focuses on private market investments.

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

It is not known that individuals will embrace private markets as much as pensions and other institutions. Many may be deterred by the higher fees and lack of liquidity that often accompany private investment. Unlike mutual funds and ETFs, private funds place limits on when investors can withdraw their money — even if future offerings aimed at individuals are less restrictive than funds traditionally sold to pensions and other institutions.

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

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

Where did the small-cap stocks go?

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

The number of U.S. public companies fell sharply in the years after 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. The number has since hovered around 5,000, as mergers and acquisitions have more or less offset new offerings.

A decade-long merger boom has made it much more likely that promising startups will end up being absorbed into titans like Microsoft Corp.

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

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

Companies once went public to fuel key parts of their operations or growth plans, said Tim Koller, a partner with 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 growing companies, both public and private, persuading some startups to go public. Others did so through special purpose buyout companies, or spin-off entities using the public markets with a stated goal of merging with a private company.

But with interest rates rising, stocks in a bearish market and SPACs facing a regulatory crackdown, the boom in new public companies isn’t expected to last. By June, the number had fallen back to 5,509, CRSP said.

“It’s fair to expect that the number of public firms will probably decline, but at a slower pace,” says René Stulz, chairman of the department of banking and monetary economics at Ohio State University’s business school.


Photo illustration:

Shawn Michael Jones for The Wall Street Journal

A heavier market

Even large public companies are getting bigger. 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 capitalization.

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

Furthermore, the companies in the Russell 2000 now account for less than 10% of the total stock market value. “And half of those stocks are micro-caps,” 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 keep.”

The change has made it harder for stock pickers to diversify their portfolios, causing some to turn to private investments.

“If our job is to find and invest in the best companies, but you have such a big decline in the small and mid-cap category that’s so important to us, it makes a lot of sense to look for those companies that can 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

Traditional clients of investment firms, including pension plans and sovereign wealth funds, still allocate a large portion of their assets to private markets. But many are close to their limits. The potential slowdown has prompted private equity firms, the largest of which are now publicly traded companies themselves, to seek a new limit to growth. Individual investors – whose access to private equity and debt has until now been limited to the very wealthy – fit the bill.

The Black Stone Inc.,

an industry heavyweight, has launched private real estate and debt funds aimed at individuals. And earlier this year, the firm sought permission from regulators to launch a new fund that gives individuals access to leveraged buyouts. The delivery was in May and since then there have been no major developments.

These funds, and others like them, offer tweaks that make them more palatable to wealthy 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. An influx of new money into private equity could make it harder for many private equity managers to outperform the public market as they have in years past. As more asset managers look to establish a presence in the private markets, some will invariably pursue some of the same deals – driving up purchase prices and reducing their bottom line returns.

“This is an ongoing cycle that we go through, where a big push towards one asset class overwhelms the attractive investments and then, as a result, the total returns are not that great,” says McKinsey & Co’s Mr Koller.


Photo illustration:

Shawn Michael Jones for The Wall Street Journal

A dark 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 leave larger private equity firms in control of an ever-larger share of the market.

Increasing private capital is also likely to reduce the amount of information available to the public. While investors in private funds receive regular updates on how properties are performing, those reports may not be as robust.

“This is a benefit for companies in terms of developing strategies and staying under the radar,” says Mr. Stulz. “If you have to disclose to investors, you have to disclose to competitors.” But he adds: “If more and more firms are disclosing relatively little compared to public firms, that means you don’t have a view of the economy that you would otherwise.”

Winners get more?

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 investment world may be tied into two groups of giants: Large-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 their market growth.

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

Mr. Koller disagrees, noting that large companies rarely maintain their dominance over time. Technology evolves and customer needs change. The conglomerates so popular with stock investors in the 1970s have all but disappeared, he says, and few 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 in Justin Baer at [email protected]

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

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