Today, the evolution of the investment landscape means financial advisors have a number of choices to provide their clients, more than at any time in history, including rapidly expanding opportunities beyond public markets such as private investments. Not surprisingly, advisors would do well to take greater advantage of various investment possibilities in seeking new and better means to meet the financial needs and wants of those whose money they manage.

After the rapid growth of mutual funds that accelerated in the 1960s and was then further boosted with the introduction of 401(k) plans in the 1980s, a large percentage of Americans now invest in public markets in some way. The more recent rapid decline in trading costs has further encouraged individuals to venture into public markets, which generally include stocks, bonds, futures, options, commodities, currencies as well as packaged versions of these investments such as exchange traded funds and mutual funds. These investments usually trade on exchanges, offering excellent liquidity, immediate price information, and robust regulation.

Previous to the advent and growth of public markets, individuals with investment dollars generally used private investments because of easier access and familiarity. A neighbor might fund a store in exchange for partial ownership, loans to in-laws were common, and exchanging services or goods often offered excellent returns. Over time, as the United States and global economy grew in size and sophistication, individuals moved away from less sophisticated deals more dependent on relationships toward more accessible and increasingly larger public markets.

Yet, in the last decade or so, this flow appears to have reversed. There are fewer public companies in existence today than there were in 1976 despite a more than tripling in the U.S. GDP over the same time period.  Since 1996, the number of public companies trading in the United States has dropped by more than half from more than 7,400 companies to less than 3,700. While the number of public companies peaked in the 1990s with the rise of the Internet, the drop in public companies that started with the dot-com bust in the early 2000s has continued for numerous reasons. 

Public companies face increased regulation, higher listing fees, dramatically higher disclosure requirements, potential risk of activist investors and seemingly countless areas of greater legal liability. In essentially all of these areas, smaller companies suffer a disproportionately higher cost burden relative to their larger competitors.

While costs have increased, the perceived benefits of going public have also declined. Private companies can now access capital at various stages of growth, often more cheaply and easily than through a public listing, resulting in private companies building most, or at least a much greater percentage, of their value before going public.

Feeding the rise in private markets and decline in public companies over the past few decades, larger entities such as college endowments and pension funds have markedly boosted their investments into increasingly sophisticated private investments as they seek to add alpha to their portfolios. A 2018 McKinsey & Company survey noted, “… 90 percent of LPs (pension funds) said recently that private equity (PE), the largest private asset class, will continue to outperform public markets…” (Source: McKinsey & Company, “The Rise and Rise of Private Markets”, McKinsey Global Private Markets Review 2018, p. 3)

The growth in private capital funding in much later phases of company development has made it harder for advisors who focus on standard equities to gain exposure to younger and smaller companies. In 2017, the average age of a publicly listed company was about 18 years old versus only 12 in 1996.

Facebook was a multi-billion-dollar company before it listed, and multi-billion -dollar companies Uber and Airbnb remain private. Compare these companies to Amazon, which listed as a small-cap stock in 1997 at a market value of $438 million. Those who took an early position in Amazon have shared in its growth to a nearly $1 Trillion colossus, while many advisors have been shut out of Uber and Airbnb.

As a result, advisors managing portfolios without private equity holdings may be missing out on considerable gains, and lack diversified exposure to the U.S. economy. In addition, concentration risk appears higher as few public companies operate in certain industries and sectors.

Some may debate both the returns and concentration risk claims, but the shift in markets has clearly altered the timing and beneficiaries of corporate growth as well as the means advisors use to access these companies on behalf of their clients.

While the growth of investments in non-public companies has increased dramatically in the corporate sector, explosive growth of private funding is occurring across multiple investment categories including real estate, private debt, oil and gas, infrastructure and more. It also appears that many of the more attractive investments are funded via less regulated and often less expensive private investments rather than through public markets.

Still, for most advisors, the choice should not be limited to choosing between public and private markets as investment vehicles for their clients, but increasingly, how to best leverage the strengths of each market while minimizing its weaknesses.

As all money managers know, public companies are generally completely liquid, offering the ease of quickly and cheaply buying or selling shares at a known price. Regulation mandates tremendous disclosure and board governance rules give shareholders tremendous rights and privileges. Yet, the market’s high liquidity also results in greater volatility and potentially significant mispricing of assets resulting from market dynamics rather than company fundamentals.

Private markets face very different forces, as their width and breadth offer advisors significant opportunity to diversify their clients’ portfolios. There are often substantially lower costs for a given dollar of earning in private markets because of the lack of liquidity. As the universe of direct investments expands, there are also fewer access challenges, partly because of newer investment structures such as interval funds and event standard mutual funds. The lack of daily pricing also results in less volatile pricing than experienced in public companies.

Yet, illiquid private investments can rarely be easily or quickly converted to cash, and while a direct or private holding may not price daily, the value is not truly static. It is simply not updated as regularly. In addition, for many advisors, the income or net worth requirements of their clients limit opportunities to access private holdings.

Still, for most advisors, private markets are likely a source of increasing interest and should probably be considered for a larger role in their client’s portfolios. Public markets certainly continue to offer many great opportunities, but increasingly, these opportunities are shrinking while the private investment world rapidly expands. The ongoing evolution of both public and private markets will likely reward advisors who understand these paradigm shifts in thinking and can adapt and leverage the changes, rather than those who remain locked into past and possibly outdated investment strategies.

Daniel Wildermuth possesses an extensive career in managing diverse asset classes for individuals and institutions, and serves as the chief executive officer and chief investment officer for Wildermuth Advisory, LLC a SEC–registered investment advisor.