Investors have valid reason to be concerned about a declining public market but thriving private equity sector, according to Schroders’s head of research Duncan Lamont.
Over the past decade, the stock market has been shrinking at a worrying pace. The number of public companies in the US and Europe declined by 2.2% per year between 2010 and 2020.
Conversely, the number of companies held privately has increased by 5.7% per year over the same period, according to private equity investor Pantheon, as companies have chosen to stay private for longer or delist.
In the UK, the decline in public equities has been particularly stark over the past year, with a rise in private equity firms buying publicly listed British companies and taking them off the stock market – UK supermarket chain Morrisons being the most notable example.
However, even though private equity activity has picked up after Brexit, it is part of a longer-term trend of shrinking public equities in the UK: the number of companies listed on the UK main market has fallen by more than 70% since the mid-1960s, according to data from Schroders.
One fund manager claimed that if UK stocks kept disappearing at its current rate of 12% per year, then the entire stock market would be gone in 8 years. But is this something investors should be worried about?
The decline of public companies and rise of private companies
Duncan Lamont, head of research at Schroders said, in theory, fewer stocks coming to the market would lead to lower returns for investors as smaller firms tend to grow quicker.
However, he noted that over the past decade this has not been the case and public markets have performed “phenomenally well”.
Something that does concern Lamont is the lack of appetite for private companies to join the stock market, which brings about less choice for investors, while those that decide to bite the bullet and buy private equity must contend with a lack of transparency.
“It's not just about this the stock market performance,” he said. “It's also the fact that the stock market has many other benefits such as transparency: that we can hold companies’ management and business practices to account in the public markets.
“You would hope private equity investors are also thinking about sustainability and the way the company interacts with environments and people, but we don't have the same visibility and transparency.”
Another area investors would notice a difference is in the fees. With the advent of passive investments, the stock market is the cheapest, most accessible way for ordinary individuals to participate in the growth of the corporate sector, he said.
“Private equity is simply too expensive and inaccessible for all but the very large investors. My worry with all of this is that it leads to greater division between the haves and the have nots.
“Ordinary people or individuals in defined contribution pension schemes typically don't have exposure to private equities. The risk is that if more of the returns get captured by private markets, those who have assets to start with, will capture more returns than those who have fewer assets.”
Some might attribute the rise of private equity funds to the rise of cheap money enabled by record low interest rates and a general decline in borrowing costs over the past decade.
If central banks were to raise interest rates it might make borrowing large amounts of money more difficult for private equity buyers.
Yet this would not slow down the process of companies remaining private, Lamont said, as private equity firms have built up a “war chest” to make deals.
“I think that public markets are going to be under threat from private equity for the foreseeable future. Private equity is going to compete more actively with public markets for finance and companies than it has done at any point in history.”
He pointed to the rise of so-called mega-cap private equity funds as one indication of the competition for financing. “They’ve got assets of more than $5bn, which means they can write checks that are much bigger than they ever were in the past,” he said.