Investment Strategies

Investors Mustn't Lose Out From Shift To Private Markets - CFA Institute

Tom Burroughes, Group Editor, 14 December 2018

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There's a structural shift going on with more firms going private and taking longer to list on stock markets. This can cause investors problems.

A shift to private from public markets for companies is driven by forces such as low yields on listed equities and reporting burdens, but the transition creates headaches such as lack of transparency for investors, a report warns.

Unlisted firms are not required to disclose as much timely information to investors as listed businesses. The lower reporting burden is a reason why many firms go off the stock market. But in this era of shareholder activism and focus on corporate governance, this shift can cause problems. It is, at least at first blush, more difficult for private investors to put pressure on a privately-held firm than a listed one because a private firm doesn't publish so much material and they tend to be less widely analysed. Academic research (January 2017) from figures at Universidad de Chile, Florida International University and Arizona State University concluded that firms were more likely to de-list if confronted with having to comply with IFRS reporting requirements. New EU regulations such as MiFID II, affecting how firms pay for company research, may also add to this problem. 

The most recent entrant into this debate is the CFA Institute, the global association of investment professionals. It highlights the scale of what is going on. In a new report, it says that firms stay private for longer and raise more capital privately than in the past.  The study estimates that the median time before an initial public offering for US companies has risen from 3.1 years in 1996 to 7.7 years in 2016. 

“Individuals are being told to save for their retirements by investing in the public markets at a time when companies are increasingly preferring to avoid or defer a public listing. This may deprive savers of the ability to participate in high-growth business models and further promote the sense that markets are being operated for the benefit of ‘insiders’,” Sviatoslav Rosov, CFA, director, capital markets policy at CFA Institute, said.

While firms are still privately held, they are also able to raise more capital: a median sum of $12.2 million was raised prior to IPO in 1996, compared with a median of $97.9 million raised prior to IPO in 2016. Related to these findings is the stock buyback phenomenon – over $3.6 trillion more was spent on repurchases than the amount raised from equity issuance between 1997 and 2015. While these trends are most pronounced in the United States, other developed markets, including the UK and the euro area, show similar shifts.

This isn't the first time that the phenomenon of a switch to private from public markets has been noted. Before the 2008 financial tsunami, the clunky term "de-equitisation" was coined by investment banks to cover the trend of public firms being taken off the stock market via buyouts, often involving large amounts of debt. The push to raise returns on equity also encouraged firms to buy back shares and use debt financing instead, adding to this process.

A combination of readily available private capital in search of higher returns in a low interest rate environment, as well as less capital-intensive new business models, has served to give new businesses more funding options than ever before, adding to the private market shift.

With firms pursuing IPOs at a later stage in their development (or simply exiting the private markets via a trade sale to a large public company), individual investors have fewer IPO opportunities and could miss out on the returns provided by rapidly growing new businesses while they are kept in private hands. And, what does eventually become public often has much of the value already extracted, the report warns.

The CFA Institute recommends a number of policy actions, including requiring more disclosure and transparency in private markets. It says stringent investor protections should remain in place. Access to private market investments by pension savers should be enabled through professional intermediaries.

On a separate but related point, this publication has pointed to how wealth managers worry that big inflows to private equity, debt and other markets create potential vulnerabilities if there is an economic downturn.

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