The Boom in Private Markets Has Transformed Finance. Here’s How

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Where do companies get their money from to grow? It was that if it were a startup, the big money for expansion would come from an initial public offering (IPO) on the stock market, while the consolidated companies would go to the bond market. These things are still happening, but increasingly, the capital behind business growth around the world is a product of private, not public, markets. In private markets, deep funds are used to make deals directly, in what advocates see as a flexible approach to providing the fuel needed by the world’s most innovative companies. Critics see the trend as promoting inequality, as there is no opportunity for the public to invest, and systemic risk.

1. What are private markets?

It is a term given to the ecosystem of investors (private equity firms, venture capitalists, institutional investors, hedge funds, direct lenders, and fund managers) and firms seeking to sell shares or borrow large sums. These are recent, but not new, ways in which JP Morgan, the quintessential private banker, worked to shape the U.S. steel industry. In the decades following World War II, these businesses were overshadowed by the build-up of solid public spaces, such as the New York Stock Exchange and the Nasdaq, which helped spread the shares widely. while traditional banks were the main source of loans.

A new stage began with the rise of leveraged purchases in the 1980s, as innovations in the bond market made it possible for so-called acquisition firms to include much larger, publicly traded companies. As the field became what is now known as private equity (PE), some of the most prominent companies, such as Blackstone Inc. and KKR & Co., diversified to buy real estate, finance infrastructure and loans to businesses. Some even take stakes in hedge funds and sports teams. A large amount of money seeking high-yield investments drove the growth of “unicorns”; startups closely valued at more than a billion dollars, almost a decade ago. What is known as private credit skyrocketed when investment firms with lots of money went into a gap left when banks withdrew from the middle market or from other types of risky loans.

• 3. How big are the private markets?

Assets in global private markets amounted to $ 10 trillion in September 2021, nearly five times more than in 2007, according to Preqin, a financial data provider. Public markets are even much larger, but have grown more slowly, doubling in about the same period. In the United States, companies that have remained private have raised more money than those whose securities have been listed on public markets each year since 2009, according to a report by Morgan Stanley 2020. In debt markets, private credit represents a fraction of the funding provided by publicly traded banks or bonds, but has doubled globally over the past five years to $ 1.2 trillion.

4. What is driving this?

For investors, private markets have offered the prospect of high returns over a period of historically low interest rates. Pension funds, endowments and large asset managers have been comfortable with a number of investments that include direct lending as well as Silicon Valley technology companies. For startups, staying private as they grow allows them to avoid periodic disclosure requirements, investor calls, and the threat of unwanted activist shareholders. For borrowers, working with private lenders can mean faster approval on better terms.

5. How do you play in actions?

New developments are changing the cast of the characters and their goals:

• Hedge funds and mutual fund managers have joined the gold rush. While PE companies still dominate the ranks of shareholders in closely owned companies, other executives go beyond the selection of stocks and public market bonds to bet more on companies that have not yet had an IPO. Investments in hedge funds such as Tiger Global Management, Viking Global Investors LP, Coatue Management LLC and D1 Capital Partners LP have increased in recent years. Securities selection funds managed by Fidelity Investments and T. Rowe Price Group have also jumped into this corner of finance. Many offers in popular startups will be recorded in the coming months, a reflection of how the field is not immune to economic changes.

• The “simple rich” are also invited. Companies like Blackstone are looking beyond the family offices of the very rich, pensions and large institutions and aim to get the cash of dentists, lawyers and the average millionaire. That is, reaching people who meet the U.S. Securities and Exchange Commission’s definition of a “qualified” or “accredited” investor with permission to purchase unregistered securities. They are bringing together sales teams to bring private equity funds to this group and to get the investments sold through wealth advisors of the banks.

• Sticky money is gaining appeal. Historically, private equity firms raised funds that were to be reduced by about 10 years. This meant that they faced strict deadlines to sell the stakes and return cash to investors. Today, private equity firms are creating massive groups with no deadline to get out of betting. The rise of these perpetual capital funds is transforming an industry previously known for shifting companies to one more focused on providing a stable income. Shareholders of publicly traded companies, such as Carlyle Group Inc. and Apollo Global Management Inc. they reward perpetual capital because they shut down investors ’money and produce long-term commissions.

6. How is private credit evolving?

Lenders are looking for bigger deals with new structures while ignoring old precautions:

• Historically, private equity firms have worked with banks to organize the financing of acquisitions. Banks would take out good junk or leveraged loans and then sell the debt to a wide range of investors. Laws and regulations that followed the 2008 financial crisis prevented banks from helping private equity firms take on debt levels that were considered too high. Institutional investors have taken advantage of the opportunities that have been created. Private lending initially focused on medium-sized or so-called mid-market firms, but the cash boom has caused many companies to now pursue larger deals that traditionally went to banks. SoftBank Group Corp., the venture capital giant, turned to Apollo for a $ 5.1 billion loan earlier this year. Another difference with bank loans: private credit companies usually have loans until maturity.

• The center of private credit history is the so-called unitranche. Syndicated bank loans can be extremely complex, with debt sculpted into a series of tranches with different levels of risk and reward designed to attract a wide range of third-party lenders. The unitranche combines two separate loan facilities, one senior and one junior, in a single structure with a single combined rate that reflects the price of the two tranches, making the experience easier for the borrower. The benefit to the lender is that in the event of bankruptcy, it is the unitranche provider, usually a lone direct lender or a so-called club of them, who is the first in the line of payments.

• In their rush to put more and more money into work, many companies are abandoning key protections, known as pacts, such as those that give lenders the right to intervene in a company’s operations when cash flows. Cash used to pay interest is impaired. Private credit offers also face what is known as liquidity risk: they are not usually traded between investors, which means that in a crisis, companies could get caught up in loans that have become aggressive. And a number of private credit arms were launched by private equity firms that often lend to their PE rivals. If a wave of bankruptcies arises, it is not clear whether these rivalries would prevent an orderly resolution.

7. What does this mean for investors?

The growth of private markets has largely excluded people other than the rich, although there is debate as to whether this is good or bad. Small investors are missing out on the opportunity to enter the ground floor in the same way they could when Inc. or Google sold shares to the public. On the other hand, they have been less exposed to money laundering such as WeWork, which raised billions of dollars before a failed IPO. Mutual fund managers face regulations on the maximum share of investments that can be tied to hard-to-trade holdings. U.S. regulators under President Donald Trump have made it clear that private equity could have a place in retirement accounts known as 401 (k) s, although the Biden administration has withdrawn the idea. Corporate supervisors of these plans are concerned about being dragged into lawsuits over whether this would violate rules that require so-called trustees to act solely in the best interests of their clients, as PE funds often charge much more than traditional trust funds. shares and bonds, taking 2% of commissions on assets under management and 20% of return on investment.

8. What do regulators say?

Since its inception after the 1929 panic, the SEC’s main tool for controlling markets has been its rules for disclosing financial information. Rising private markets make regulators and governments less visible about parts of the economy. Private equity firms are also regulated more lightly and face looser disclosure rules than money managers who cater to retail investors, leaving regulators with more blind spots on the risks that buying companies can pose. . In response, the SEC has proposed rules that require companies operating in private markets, whether in equity or credit, to provide more data and disclose rates clearly to investors. Other proposals would cost them higher risk levels.

• A Bloomberg News article about Blackstone raising funds to seek investments from the “simple rich.”

• An article on the SEC’s push for new regulations for hedge funds and PE companies.

• Guidance issued by the US Department of Labor in 2020 on private equity investments and retirement accounts and its clarification in 2021.

• An overview 2020 of the private credit market by the Alternative Credit Council.

• An article on delinquency levels in the private credit markets.

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