How Private Markets Are Impacting Public Markets

  • Posted by on June 30th, 2015 at 12:40 am

I believe that active management has a place in everyone’s portfolio. With that said many people might do reasonably well over time if each month they simply dollar cost average in a simple portfolio that consist of an U.S. equity index like the S & P 500, a few international  ETFs that cover both developed and emerging markets and some muni bonds. This approach has helped consistent savers to average about 6-7% per year over the past 30-40 years.  Can we expect this approach to continue to work in the future? No one could know for sure. Past data is all we have. Any speculation about the future is just that – speculation.

There is a good reason to opine that the 6-7% average annual return that a diversified portfolio has returned over the past will significantly diminish in the future. The cause – private markets have changed substantially. In “The Next Apple”, we wrote that investors need to adjust their expectations about new IPOs:

Nike, Microsoft Amazon and similar companies went public relatively early in their growth cycles. As a result, public investors had the opportunity to participate in 95 to 99% of their overall price appreciation. Founders, early employees and VCs took all the risk. Most of the reward was left for grabbing – anyone could’ve bought those stocks on the secondary markets.

As the Federal Reserve prints more money and interest rates remain low, an increasing percentage of capital is flowing into risky asset classes like venture capital and “angel investing.” This capital has chased up valuations in the pipeline preceding IPOs, making the IPOs feel more like the end of the journey, not the beginning. Thus, investors must adjust their expectations and understand the new metrics in the context of the speed at which companies are being created, growing staff and revenue, and expanding globally.

It has become harder to get small companies to market. The venture capital industry is playing the role that the public market used to play for micro-cap IPOs. As a result, nearly all of the market value of public technology companies is accruing while they are still private.

The IPO market has changed tremendously over the past few decades. It used to be that companies went public because they needed cash to expand. In 2015, high-growth companies can raise all the money they need in private markets.

Look at the data below, and tell me if you notice a trend: Total VC money ever raised by select companies:

Microsoft: 1MM

Apple: 3.6MM

Intel: 2.5MM

Cisco Systems: 2.5MM

Google: 25MM

Webvan: 441MM

Facebook: 2,426MM

Uber: 4,000MM

The growth that is supposed to come from young public companies isn’t likely to be come. Nowadays, many of the companies with a great growth story are staying private longer and going public as much more mature companies. As a result they leave a lot less meat on the bone for public investors. This trend is likely to accelerate.  This means that simply buy and hold an index isn’t likely to work as well as in the past. The only way to have a shot at achieving good returns in public markets today and in the future is active management, which includes timing market exposure, swing trading, position trading, trend following, proper risk management.

Just my biased opinion.

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