PART IV: Public Markets Tune In

Gintare Hennick
20 February 2024
We have previously discussed the current private market dynamics, the new era of institutional investors and huge but largely untapped segment of private wealth. Now we turn to the last chapter of our private market series, where we focus on the impact of public markets.

Tale of Two Cities
We have discussed that 2023 has been a turbulent year in both private and public markets. On the private side, the fundraising activity has decreased by 30%, the global M&A activity plunge to a decade low of $3tn, with private equity-led buyout volumes globally plummeting by 38% to $433.6bn, the increase in interest rates and the denominator effect have generated all the doom and gloom headlines about private markets.

Or did it? Have you recently checked the share price of publicly listed private capital asset managers such as Blackstone, KKR, Carlyle, TPG? Well, we have and we are astonished! The share prices across the board (with handful of exceptions) surged anywhere between 27% to 104% in some of the largest publicly listed private capital asset managers, for the period 30 December 2022 to 19  February 2024, with accelerated uplift in 2024. Yes, these are established companies with billions of AUM, no unicorns here. In comparison, the largest US banks have substantially more patchy performance for the same period. According to Financial Times, "Private equity chiefs enjoy $40bn gain in share value as assets surge". Some executives have seen their holdings' value more than double in one year. But why the urge to pour public equity flows to private markets players?

Source: Price data Google Financials & Hargreaves Lansdown. Reference period for share price change is between 30 December 2022 and 19 February 2024. Prepared by Digipeak Group.

Source: Financial Times "Private equity chiefs enjoy $40bn gain in share value as assets surge"

What's the Rush?
Several factors might be at play: historically low returns from traditional banks and financial sector rotation; future business opportunities better suited for private credit managers rather than traditional lenders; the significant AUM growth in private markets and potentially more stable cash flows. For one, Citi Wealth Outlook 2024 report listed private capital asset managers in their top 10 investment ideas for 2024 as a potential replacement for US bank exposure. In 2023, US bank equities underperformed with a -6% return, a 35-year low compared to S&P 500. The regulatory pressures and higher cost of capital might put further pressure on the traditional banks and pave the way for private capital players and alternative financiers. On a similar point, according to JP Morgan, there is a looming "refinancing wall" in the global high yield market, especially at 2026-2029 maturities. With traditional banks significantly constraint to take on more debt and private credit managers offering more flexible terms, the latter has an opportunity to grab a bigger share of credit market.

The other important driver is accelerated AUM growth in private markets and potentially more stable cash flows. Yes, more stable cash flows in this instance. Investing in publicly listed asset managers should not be confused with investing in private markets funds directly as a Limited Partner. The underlying investment exposure can be similar to some extent, but the return profile and cash flow profiles are very different. Publicly listed vehicles largely rely on growing AUM and hence generating rather stable flow of management fees. According to Financial Times, the private equity groups generated $15.5bn in fee and spread-based earning in 2023, an 11% increase from prior year. The significant share price increases will undoubtedly attract attention, but it is only one piece of a puzzle. The investors will need to understand what they are actually buying and what are future prospects of their investments. We believe it is still early days to decide whether this share price gains is a new normal or short-lived herd effect.

Source: Citi Wealth Report "Wealth Outlook 2024"

Source: JP Morgan report "Investment Outlook 2024"

The Next Big "Thing"
The IPO market has been largely stagnant over the past couple years, especially when compared to 2021 highs. PwC suggests that "increasing economic confidence as the macroeconomic landscape stabilises, growth in equity indices and a backlog of demand for exits all point to potential re-opening of Western IPO markets in 2024". We argue that the market will be as opportune as any to IPO private capital asset managers. Whilst investors are still cautious about loss making or low profitability tech companies, the more established firms with a proven track record, money-making-machine business module and measurable performance, will make private capital managers a very attractive pitch to investors. Especially given the recent surge in share prices amongst their peers. Some have made these plans last year but decided to postpone (CVC or General Atlantic). Perhaps, this year we will some more financial sector IPOs, less flashy than start-ups but definitely very interesting to consider.

The past year has shown that there is an increased interest from public markets investors to look at private markets. Is it a short-term allure or long-term trend, remains to be seen. We know one thing for sure, to be a good investor one needs to understand how private markets work at public and private investment level to be able evaluate the prospects and dynamics at play. We will continue our quest to analyse and learn more about private markets. Stay tuned!

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