March 21, 2018

Overcrowding in U.S. public equity: Why private equity is taking market share

There are nearly 20,000 U.S. equity mutual funds in the market, and about 2,300 ETFs. The irony is that there are only 3,492 U.S.-headquartered companies that are publicly traded, active, and available for investment (as of 12/31/17). This means there are more than six times as many equity products as there are equities! The number of U.S. stocks is down 46% from a peak of 8,025 publicly traded companies in 1996. The market has become highly concentrated, with multiple investment products drawing from the same small pool of investments. For instance, if you invest in a U.S. large cap mutual fund, chances are high that you would see very similar holdings (and many of the same holdings) in other U.S. large cap mutual funds. The marketplace is becoming crowded, and public investments are spread thinly across their investor population.

Why are there so few publicly traded companies, and so many fewer than there have been in the past? The answer is simple: more and more companies are choosing to stay private. Airbnb, Deloitte, Uber, Mars, Bechtel, Bloomberg, and Meijer are just a few companies that have made this increasingly popular choice. The costs of going public can be very high, and companies are finding it more efficient and effective to avoid the regulatory burdens. It has become cheaper and easier than in the past to raise capital without going public; companies are able to borrow at low cost and to seek out private venture capital. Staying private also means having to contend less with share price fluctuations due to market volatility.

Additionally, merger & acquisition activity contributes to the concentration in public markets. The trend in many industries is toward convergence – such as energy and construction or retail and technology – resulting in larger but fewer companies. 2016 was the third-best year on record for M&A deals.1 And in 2017, we saw a few giant mergers, such as Amazon and Whole Foods, Cisco and BroadSoft, and CVS and Aetna.

Private Markets

The fact is that there is no dearth of companies in which to invest; where public equity is dwindling, private markets are picking up the slack. Forbes Magazine’s Antoine Drean says, “This is the golden age of private equity investment.”2 Between 2000 and 2014, while public stocks were decreasing, the number of active global private equity firms rose 143%, most of that in the U.S.3 In 2017, U.S. private equity saw $538 billion across 4,053 deals.4 The entrepreneurial spirit is alive and well in the U.S. — it just seems to be moving more toward private markets. For investors seeking to expand beyond the crowded public market, private markets as an alternative are becoming ever more attractive. The return potential is generally greater than in equity markets for investors who are willing to take on the risk and illiquidity that comes with private equity investing.

U.S. Private Equity Activity

Source: Pitchbook

Don’t try this at home!

To venture into private markets requires specific experience and knowledge. There are reasons why they are fairly exclusive markets, not to keep investors out but to ensure that they are equipped with adequate experience and understanding of how investments are structured, what the risks are, and what to expect as an investor. Arnerich Massena has experience working within private markets since our inception in 1991. We believe that the opportunities in these spaces are highly attractive, particularly as public markets become ever more crowded, and are working toward making alternatives and private equity more accessible for investors.

 

1 “The 4 Biggest Trends in Mergers and Acquisitions for 2017” by Bryan Borzykowski; Forbes; Jan. 13, 2017

2 “10 Predictions for Private Equity in 2018” by Antoine Drean, Forbes; January 24, 2018

3 “Number of active PE firms up 143% since 2000: A global breakdown,” Pitchbook; June 10, 2015

4 “US PE Breakdown, 2017 Annual,” Pitchbook; Merrill Corporation; 2018