The hunt for high growth

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Just as the Covid-19 pandemic has kept people at home, it also has kept companies from going public. Is this a temporary blip or an acceleration in the decline of IPOs?

Initial public offerings (IPOs) have been declining globally for a decade but as the impact of the Covid-19 pandemic spread through economies and markets in the first half of 2020, IPOs practically ground to a halt. In Europe, just 28 IPOs completed, compared to 53 in the first half of 2019, with proceeds of €5.4 billion compared to €12.2 billion the year before.1 The drop was even more pronounced on the London Stock Exchange, which saw just one IPO (of a venture capital trust) in the second quarter.2

In Europe last year there were just 106 IPOS, compared to 457 in 2011, with a value of 22 billion - a little more than a third of the value seen in 2015. In contrast, private markets have tripled in size from $2.5 trillion in December 2007 to $7.7 trillion in 2020.

While it is still too soon to see if Covid-19 is accelerating the decline of IPOs, investors have been increasingly turning to private market assets in search of better returns and diversification.

The growth of private markets

Private market investments include all illiquid investments, but private equity (PE) and venture capital (VC) are two of the best-known categories. While VC funds invest in start-ups and other young business that show the potential for long-term growth, PE tends to support more mature businesses that may need capital to make significant changes. Both are vital to fund companies before they are ready to IPO, or as an alternative to going public.

There are numerous reasons behind the growth of private markets, one of which is an increasing desire of some companies to stay private longer. The cost and hassle of listing and remaining a public company have grown significantly. More mature companies which have been public may use PE to go private again.

The growth of passive investing has also made going public early less appealing to companies. Smaller companies are not big or liquid enough to be included in many of the indices tracked by passive funds, and the remaining active investors seem less willing to take a chance on smaller firms. Institutional investors are allocating a large and growing share of their assets to private markets instead. With their long-term liabilities, they can be patient and take a longer view, sacrificing liquidity for better returns. The resources and sophistication of institutional investors are also needed to find the right opportunities, as there is less data on private companies.3

Accessing private markets

Compared to publicly listed assets, private market assets have less accounting volatility, are insulated from sentiment, are less vulnerable to forced selling and some assets are less correlated to public markets. However, they are longer term and less liquid than their public counterparts, which is why private markets mainly have been the preserve of institutional investors.

As the market matures, more products have been developed which can offer the returns of private markets in a structure more suited to the individual investor. Funds of funds, which hold shares in private partnerships, or ETFs that follow an index of publicly traded companies that invest in private equities are options.

Because of the lack of publicly available information on private companies, underwriting rigour, discipline and patience are needed to find the right investments. This has only increased with Covid, as investors demand fuller disclosure and analysis from corporates on their assumptions and scenario planning. While the future is always uncertain, it seems particularly so now, especially in certain sectors.4

Investing for recovery

Where there is risk, there is opportunity and these unprecedented times could prove a boom time for private markets. The private market vintages (the milestone year in which the first influx of investment capital is delivered to a project or company 5) right after the Global Financial Crisis were some of the best ever and the current market presents a similar opportunity to benefit from the economic recovery.

The current environment is not the same as post-GFC because of the maturity of the sector and the availability of capital. It is also different as the recovery will not be one that ‘lifts all boats’ - there will be a greater dispersion of outcomes across economies, sectors and businesses as the pandemic drives structural changes in the economy.

However, well-chosen private assets can still provide better returns and spreads, in protected structures, than more liquid assets. The impact of Covid-19 and the resulting market volatility underscores the role of private assets in building more resilient portfolios.

[1] PWC, IPO Watch Europe Q3 2020, July 2020  

[2] EY, IPOs all but absent in Q2, but existing issuers rushed to market to raise cash, July 2020

[3] The Economist , Privacy and its limits: Everyone now believes that private markets are better than public ones, January 2020  

[4] PWC, IPO Watch Europe Special Edition: Dealing with the impact of Covid-19, June 2020

[5] Investopedia, Vintage Year, August 2019

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