Posted by Assure Analytics ● Jan 21, 2022 2:19:03 PM
Evolution of the Private Markets: Staggering Wealth Increasing Demand for Private Market Investments
This latest installment of the "Evolution of Private Investing" will examine some of the tailwinds, strategic shifts, and market dynamics driving demand for alternative assets.
Since the Global Financial Crisis (GFC) in 2008 / 2009, the public markets — in particular U.S. equities — have seen extraordinary returns well above historical norms. Investors of all shapes and sizes, from pensions to endowments to individuals, have seen their portfolios surge. Over the same time frame, many investors who allocated capital to alternative assets (in particular venture capital and private equity) saw even better returns.
The accumulation of wealth often leads to demand for new and interesting investment opportunities, while necessitating portfolio rebalancing. Over the last decade, this has had a profound impact on the private markets. In this article, we’ll explore some of the tailwinds, strategic shifts, and market dynamics driving demand for alternative assets.
This is Section 5 in our evolution of private markets series. This and other segments in our series offer chronology and context on how the private markets got to where they are today. The parts of the series includes:
- Section 1: Evolution of the Private Markets: An Assure Series
- Section 2: Necessity is the Mother of Invention — Rise of Entrepreneurship
- Section 3: Technology Transforms Investing
- Section 4: Investment Landscape Shifts, Regulation Opens Market to More Investors
- Section 5: Staggering Wealth Creation Drives Increased Demand for Private Market Investments (Current Article)
- Spotlight: Assure’s Role in the Innovation of Private Markets
Let’s examine some of the key demand drivers affecting the private markets.
Rich Valuations in Public Equities Affect Mindsets
The public markets — in particular U.S. equities — have seen outsized returns above historical norms for the last decade. Take the S&P 500, for example, which averaged a 16% annual return over the last decade, versus 10-11% in prior years. This trajectory continued in spite of the global pandemic, where public equities in March 2020 saw a much shorter (albeit faster) drawdown than during the GFC.
Yet growth in the underlying economics of publicly traded companies has not kept the same pace: stock prices have risen much faster than the financial factors that usually underpin them (revenue, EBITDA, etc). This has led to rich — some say overly rich — valuations in the public markets. Despite expansionary global monetary policies that can stimulate asset prices, these valuations are giving some investors pause and causing them to consider allocating more capital elsewhere.
Forward projections for public equity performance suggest the stock markets will see comparatively mediocre to poor returns over the next decade. While we can debate the accuracy and merits of such projections, they’re certainly a barometer of perspectives among investors. And perspectives matter, because they shape what people are willing to pay for assets and where (and whether) they’re willing to invest.
Tailwinds of Wealth Accumulation
Many factors influence the accumulation of wealth for individuals, families, and institutions. While entire books and reams of academic research are regularly written on this topic, we want to highlight a few major tailwinds influencing today’s state of wealth.
2009 to today — Public equities performance. As discussed in the prior paragraphs, the public markets — particularly U.S. equities — have seen historically above average returns since the Global Financial Crisis. This has created huge sums of wealth for portfolios with exposure to the public markets, and has led to regular rebalancing of assets elsewhere (frequently to the private markets).
2009 to today -- Rapid rise in U.S. household wealth. While partially a function of public equity performance, household wealth is also driven by monetary policy, government policies, economic performance, currencies, savings rates, growing rates of business ownership, investments in other assets, and more. The takeaway is that (average) household net worths have grown significantly since 2009 to new highs. Accumulation necessitates allocation, and growing household wealth represents new amounts of capital that can be invested across all kinds of assets and may prove to be a long-term tailwind for the private markets. And the growing affordability of SPVs makes the private markets increasingly accessible to more households. (Of course, it’s worth noting that wealth inequality has also increased substantially over the last decade, with the vast majority of gains accruing to wealthier households. It’s also worth noting that homeownership is the primary driver of wealth for many Americans, and the recent appreciation in real estate has buoyed the net worths of homeowners across the board.)
2016 to today — Baby Boomers begin turning 70, marking the start of a generational wealth transfer to their heirs. While this wealth transfer occurs gradually year by year, it’s estimated that American Baby Boomers alone control $35 trillion in assets. Those that inherit this capital are very likely to change wealth advisors (or go it alone), with studies suggesting 80% of heirs will look elsewhere for financial advice. Younger investors are quick to adopt new investment technologies and asset classes (including the alternative asset platforms mentioned in Section 4, many of which launched since 2016). We’ve seen aspects of this show up in the private markets, with younger generations increasingly interested in alternatives and impact-oriented investments. We’ve even seen this in Special Purpose Vehicles at Assure, where a sizable segment of our most active SPV organizers are of younger generations.
The power of this wealth transfer cannot be understated; it is global in nature, decades in duration, and trillions in size. It represents a longer term tailwind that will reshape markets and how assets are allocated and managed.
Increased Demand for the Private Markets
Demand for alternative assets is growing fast. As discussed previously, high stock valuations, low yields, portfolio rebalancing, improved access to alternatives, diversification strategies, and performance expectations of assets are all factors.
Private assets “....are expected to rise 60 percent between 2020 and 2025 [and] exceed $17 trillion in assets under management,” with allocations to private equity expected to grow the fastest (15.6% per year).
More Demand Leads to More Competition, New Strategies
With increasing demand for private assets comes new investment products and strategies. Capital flows certainly increase competition within asset classes, but they also fuel innovation. In prior sections of this series, we’ve discussed a host of new investable products, platforms, and approaches. The rise of Micro VC funds and their diversification / specialization of investment theses is just one component (as discussed in Section 4). The emergence of alternative asset investment platforms is another. The role of SPVs in supporting efficient and fast investments adds to the pattern.
But other recent developments are worth highlighting as well. As an investor, it’s helpful to understand the changing strategic and tactical landscapes in alternative assets.
2018 — Private Equity firm Tiger Global ramps up its startup investing. While no stranger to startups, 2018 and subsequent years saw an incredible acceleration of the number of deals and size of capital Tiger invested into startup companies. The first half of 2021 saw Tiger invest in 118 companies, 10x the pace of the year before. Other traditionally private equity and hedge-focused pure-play firms such as Coatue, Dragoneer, and D1 have followed suit. Their investment style is characterized by speed and aggression: they invest large amounts of money very quickly. The incentive driving these firms is to gain large ownership in promising private companies before they go public or are acquired. The consequence is greater competition in late and mid-stage startup investing, with some other investors (such as large VCs or Corporate VCs) getting beat out. That said, the ‘value’ offered by these hedge funds does not resonate with every private company.
2018 — VCs and other investment funds raise dedicated crypto funds. As hedge and private equity funds leaned into venture, some venture firms began to lean into blockchain and cryptocurrencies with dedicated investment vehicles. In 2018, A16Z raised its first crypto-focused fund; in the summer of 2021, A16Z raised its third crypto-fund with $2.2 billion in committed capital. (Other investment managers, of course, have raised dedicated funds as well). This further signifies adoption of new strategies in the private markets.
2019 — The average number of LPs in venture funds begins to noticeably tick up. Between 2016 and 2021, the average number of LPs investing in a VC fund more than doubled. While these LPs are assuredly a mixture of high-net-worth individuals, family offices, and institutions (such as pensions or endowments), the data clearly shows more investors are investing in more funds, and more funds are willing to accept money from more investors.
2020 — SPACs drive the public equities narrative. SPACs, or Special Purpose Acquisition Vehicles, are fundamentally a simplified vehicle for taking a company public. Starting in 2020, their usage skyrocketed — the number of SPAC offerings grew 5x from 2019 to 2020 (59 to 248, respectively), and more than doubled again in 2021 (613). That’s 10x in two years. While SPACs are publicly traded, they’re indicative of the demand for access to high growth startup companies. They also provide liquidity to existing investors (angels, VCs, secondary funds, etc), allowing them to realize gains and reinvest that capital elsewhere.
2021 — Investors lean into real estate. U.S. real estate investors spent a record $63.6 billion on 90,215 home purchases in the 3rd quarter of 2021. Institutional investors, while a relatively small component of the single family rental (SFR) industry, have been adding to their SFR positions in addition to other real estate sleeves such as multifamily and industrial. This is yet another aspect of growing demand for the private markets.
The breadth of change in the private markets over the last several decades is massive. Demand for private assets is growing due to easier access, new and novel strategies, new generations rethinking portfolio construction, and growing interest in greater diversification and performance enhancing assets. The power of the massive Boomer wealth transfer cannot be understated; it is global in nature, decades in duration, and trillions in size. It represents a longer term tailwind that will reshape markets and how assets are allocated and managed.
The last decade’s strong run in publicly traded equities has led many investors to regularly rebalance capital towards the private markets. Today’s multi-decade high stock valuations are giving some investors pause, with banks’ capital market assumptions forecasting weak returns across public equities and bonds, and comparatively stronger returns across alternative assets.
With this growing demand comes new strategies and tactics across the private markets: hedge funds are shifting into private equity; VCs are looking at blockchain; SPACs have become the liquidity mechanism du jour; syndication is on the rise; SPVs are gaining preference; real estate has seen record-level capital inflows. Yet despite all this, we are still in the early innings of private market investing. The coming access and innovations will continue to make it easier, faster, and more efficient for investors of all shapes and sizes to invest in private assets.
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