Private Markets Outperform Public Equities

Since 2004, top quartile PE and VC funds have significantly outperformed the public markets by more than 5x¹.

Make sure your clients benefit from this asset class.

August 26, 2019

Private Markets Outperform

The outperformance of private equity compared to public equities is widely publicized, with data from a range of providers showing that the former has outperformed the latter, often significantly.

study 1: pitchbook - private equity outperforms by 5x ¹

Private Markets Outperform Public Equities Graph - Pooled Quarterly Aggregate Changes to NAV (rebased to 100 in January 2020)

A survey conducted by Pitchbook in Q2, 2019 revealed that of the 101 institutional limited partners (LPs) and public equity allocators interviewed, 66% said they would be increasing, slightly or significantly, their allocations to private market strategies (PE, VC direct investing) over the next five years. That percentage far outpaces other asset classes, most of which will likely stay the same or go down slightly. According to the findings, the increase in allocations to private equity is primarily due to consistent outperformance of this asset class.

The top 25% of PE and VC managers have significantly outperformed public markets to the tune of 5x or more.

The above chart is an index based on the pooled quarterly aggregate changes to net asset values for PE and VC funds, top-quartile PE and VC funds (funds in the top 25% of performance) and the S&P 500. As illustrated, the top 25% of PE and VC managers have significantly outperformed to the tune of 5x or more. Note, private market NAV metrics include net fund inflows into private investment vehicles. This spans a full business cycle and includes both the financial crises and the last decade’s record bull market. With return potential such as this, it is not surprising to see capital continue flowing into private markets.

66% said they would be increasing their allocations to private market strategies over the next 5 years.

Private Markets Outperform Public Equities Graph - How do you see your target allocations to the following asset classes changing over the next five years?

Higher potential returns than the public markets, diversification benefits and increasing amount of attractive investment opportunities were the top three reasons why institutional investors believe the private markets have continued to attract hundreds of billions of capital.

Private Markets Outperform Public Equities Graph - Why are private markets continuing to attract record amounts of institutional capital?

Study 2: JP Morgan Asset Management - Private Equity Outperforms World and U.S. Public Equity ²

A similar analysis was conducted by JPMorgan Asset Management in 2018. In the case of private equity, the primary motivation for investing is clearly potential return enhancement. Over the long term (10 years or more) private equity has outperformed traditional public equity markets.

Over the long term, private equity has outperformed world and US public equity.

Private Markets Outperform Public Equities Graph - Exhibit 1: Private Equity Time-Weighted Performance VS. MSCI World and S&P 500

JPMorgan Asset Management also estimates that in the 15 years through the end of 2017 private equity generated a 14.4 percent net annual return versus 8.8 percent for the MSCI World equity index.

Study 3: Hamilton Lane and JPMorgan Asset Management - Private Equity and Downside Risk Protection ³

Less appreciated than private equity's outperformance is its inherent downside risk protection. Research from Hamilton Lane and JPMorgan Asset Management shows that two-fifths of publicly-listed equities experience “catastrophic loss,” defined as a 70 percent or greater drop from peak value, with minimal recovery. Yet less than 3 out of 100 private equity funds suffer similar loss. In this regard, stocks are a stunning 13 times riskier than private equity funds.

A recent 47-page study builds on this idea that private equity is less risky than many assume. “Private Equity and Financial Fragility During the Crisis” compares the performance of nearly 500 private equity-backed companies in the United Kingdom with non-PE-backed peers of similar size, purpose and profitability. The UK was singled out for study because private equity-owned assets at the time of the 2008 global finance crisis – the period considered – represented some 11 percent of gross domestic product, the largest share in the world.

How has Recent Reality Played Out?

As public pension funds pioneer private equity investing, they have experienced the following results:

For American pension funds, private equity has generated an aggregate 10.2% return over the past 10 years, according to the American Investment Council, which just released its annual public pension study covering 165 U.S. public pensions .

Private Markets Outperform Public Equities Table - American Investment Council Public Pension Study

The San Francisco retirement system has managed to beat its annual expected rate of return for the 2018-2019 fiscal year despite a volatile equity market.

The San Francisco Employees’ Retirement System (SFERS) reported investment returns of 7.81% for its 12-month fiscal year ending June 30, beating its expected annual rate of 7.4 % by more than 400 basis points, shows a report by Chief Investment Officer William Coaker Jr. The report details that the $25.7 billion system’s strong private equity returns of 17.4% helped propel overall returns, despite mixed public equity returns.

At 21%, the San Francisco system has one of the largest allocations to private equity among public pension plans in the US .

Public equities, which make up 55.9% of the SFERS portfolio, its largest asset class, saw investment returns of 5.84% in the fiscal year, less than a third of the private equity results. Public equity makes up almost $9 billion of the SFERS portfolio.

The results have led to proactive changes in asset allocation.

The Teacher Retirement System of Texas, the 6th largest pension fund in the U.S., announced that it plans to increase allocations to private equity, real estate, and energy, natural resources, and infrastructure holdings, in an attempt to protect the plan from equity risk, as a stock market downturn in the near future is a growing concern for investors .

The Convergence of Public and Private Markets ¹

Over the last decade, $10.7 trillion (including equity and debt) has been invested into companies by private equity and venture capital investors globally, which has produced a record number of private companies that are privately-backed (PE or VC backed). In the US, there are 13,695 privately-backed companies compared to 4,397 publicly listed companies today – down from 6,917 in 2000. This steady growth has impacted where investable opportunities are located and created increased convergence with the public markets. One example of convergence is the IPO market, whereby the private markets serve as a pipeline of companies transitioning to the public markets.

There are 13,695 privately-backed companies compared to 4,397 publicly listed companies today.

Currently, 44% of Companies Listed on NASDAQ were Formerly PE or VC Backed.

Former PE- and VC-backed companies make up roughly two-thirds of NASDAQ company market caps. Among these are tech giants such as Facebook, Alphabet and Netflix, but also companies such as Kraft Heinz, lululemon athletica and the Dunkin’ Brands.

Private Markets Outperform Public Equities Graph - Former PE and VC Companies on the NASDAQ

Other points of intersection include, disruption of public companies in established industries from agile private companies, the uptick in take-private transactions and increased acquisitions of private companies ¹.

Global Private Market Strategies are Growing and will Continue to Grow for the Foreseeable Future

It is believed private markets will continue to increase their role in global capital markets regardless of what happens at a macro-economic level over the next decade. This growth will be enabled by the robust ecosystem of investors, lenders, advisors and executives that has been built up over the last 20 years in the private markets. With this foundation now in place, it is expected that private markets will keep growing in size, sophistication and global impact ¹. Financial advisors should take advantage of this progress, and maintain meaningful allocations to private markets as part of their overall investment strategy for client portfolios.

¹ Pitchbook – Private Markets: A Decade of Growth, July 2019

² J.P. Morgan Asset Management, Feb 2018

³ Forbes, October 2018; Private Equity and Financial Fragility During the Crisis

Chief Investment Officer, July 31, 2019

Chief Investment Officer, July 29, 2019

Chief Investment Officer, July 23, 2019

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