Foresight - Managers' views

Equity investors narrowly focused on public markets risk missing out

The number of listed companies has collapsed in many parts of the western world over recent decades.

29/11/2019

Duncan Lamont, CFA

Duncan Lamont, CFA

Head of Research and Analytics

Stock markets were traditionally a venue for companies to raise money to finance growth. However, although we have seen quite a few major initial public offerings in 2019, the number of listed companies has collapsed in many parts of the western world over recent decades. This suggests that markets perform this function less and less. Easier access to alternative sources of financing alongside the increased cost and hassle of a public listing are all partly to blame. Savers and policymakers should all be concerned about the implications. All is not lost, however. Equity markets are thriving in some parts of the world, including Asia, and they continue to serve an economic purpose, albeit one that is different to the original blueprints.

Companies shifting from IPO to other sources for capital

The initial purpose of the stock market from a company’s perspective was to provide it with a means of raising capital to finance its future endeavours. Over the years, we have seen dramatic declines that were driven by both a slump in companies choosing to IPO and greater numbers choosing to delist than list. However, such decline does not indicate a lack of entrepreneurialism. Instead, this may be a sign that companies are choosing to finance themselves differently than in the past.

When companies are trying to raise capital, it makes sense to raise it where it can be done most cheaply. Subject to constraints on leverage and long-term affordability, debt finance under the current low interest rate environment has increased in attractiveness relative to equity, not to mention it is also significantly cheaper than equity in upfront fundraising cost terms. All told, it is not hard to see why debt has been popular, although its glamour may start to fade if interest rates and borrowing costs (eventually) rise.

Private equity is now a more viable long-term option

Another important development has been the ability of companies to raise sums of money privately that previously would not have been possible outside of public markets. In just the past few years, the figures have skyrocketed, with one Chinese online financial services provider topping the scale, raising over $18 billion in equity financing privately to date. Several other companies spread across Asia and the US have also raised more than $10 billion. The ability to raise such huge sums privately defers one potential need for a public listing.

Now that the private equity industry has grown substantially in scale and accessibility, it is competing much more acutely with the public market. Global private equity assets under management stood at $3.4 trillion at the end of 20181, a record high and more than six times larger than in 2000. Although still small relative to the $41 trillion market capitalisation of MSCI All-Country World public equity index, private equity has grown almost three times as fast over this period.

Too soon to bid farewell to equity markets

Although equity markets have been a declining force in some parts of the world, they have continued to thrive in many countries. Emerging markets have fared far better than developed, driven by buoyant growth in the number of listed stocks. For example, China has rapidly expanded from just over 100 companies in 1993 to over 3,000 now, and is continuing to grow at a rate of several hundred a year. This unprecedented growth come as a result of the booming capital demands in the fast-growing economy, where such needs are met by primary (IPO) and secondary issuance in the public equity markets, as well as debt finance and private equity. However difficult it is to ascertain the whole truth, there is clear evidence that it would be premature to call time on public equity markets.

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So, what is the point of the equity market?

Public equity markets have long been the cheapest and most accessible way that savers can participate in the growth of the corporate sector. Private equity is excluded on cost or accessibility grounds for many. However, with companies choosing to stay private for longer, investors who focus solely on public markets will miss out on an increasingly large part of the economy. Moreover, many of these companies are in high-growth disruptive industries. If high-quality companies find little reason to go public, then the risk is that over time the quality of the public markets deteriorates. Should this occur, then it is possible that returns from public equity markets in aggregate could move structurally lower relative to private markets. It is our responsibility, as active investors, to do all we can to help our investors achieve their goals and navigate any such changes in the market environment.

In order to maintain their access to these opportunities, investors will need to broaden their scope and embrace private assets, where able. A more holistic approach to equity investment, where public and private market exposures sit alongside each other, is likely to be more appropriate. However, this does not mean that investors, managers, companies, regulators and politicians are relieved from their responsibility of ensuring that public markets retain their crucial role in the proper functioning of economies.


1 Figure excludes real estate, infrastructure, and natural resources. Source: Private markets come of age, McKinsey & Company, February 2019.

 

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