Why are private markets outperforming public markets?
I've read numerous articles that are stating private markets (including pe, debt, real estate, etc) are outpacing public markets and having much stronger returns in recent years.
Why is this happening and will this continue?
Is this a good time to get into private equity/re/private debt vs public market functions? Why?
Here's a 2018 report from McKinsey on Private Markets I found interesting and made me post this question.
Fake. Private equity returns are largely marketing .
Once you factor out added leverage and small cap premium the returns are far less impressive.
If you used similar leverage on sp 500 futures the futures would dominate.
once you factor out drivers of return, the returns look less impressive? no shit
I currently work in private markets. It does boil down to liquidity premium at some level; but private markets provide a lot of room for innovative return unavailable in public markets if done correctly.
Public markets don't serve all companies well - companies may find themselves capital-constrained without adequate time to access and syndicate from public markets. Banks and other asset managers have risk, size, and liquidity constraints that prevent them investing or lending to certain companies; and they make money perfectly well in public markets.
Thus, companies below a certain size or in a time-crunch may find the debt or equity they wish to issue is too expensive in the public space. They go to private markets (PE, family offices, sponsors, and boutiques) who recognize the potential opportunity in the prospective investment; and are generally offered a higher return for the lack of liquidity and other potentially unattractive aspects (size, overloaded debt ratio, etc.)
However, the true value in private markets is the ability to tailor your return structure to suit the needs of both the investor and issuer. Company needs a ramp up for three months after Litigation expense? No problem - interest can be accrued as a PIK for that period only. Company will generate increasing cash-flow at an exponential rate? We can schedule the amortization schedule as an exponential rate as well. Coupon is too low for a given risk profile? We can extract surplus return via private leverage (PE firm or other stands in as creditor), ask for extra warrants, set OID rate, etc. Factors that are exotic to a normal credit or equity investor can be regularly structured in private markets for attractive return.
Blackstone's Tac Opps is a good example of opportunistic private-market investing; although I believe their general mandate is public/private.
That being said; bad private market investments are near-impossible to sell off, so it does eventually come down to the question of liquidity. Like everything else, no free lunch.
I would argue it's unfair to judge average private market returns vs that of public markets. With public markets, all players deal with far more equal access to information and more limited levers to pull for adding value.
The private market is incredibly opaque and there's more ways to add value but at the cost of liquidity. Because of these aspects, the information advantage and operational gaps are much wider across players, which makes professional relationships far more valuable and differentiating than the public markets. In this environment, a fund with great relationships will outmatch a fund with no network several times over with better deals, better people, and more opportunities. This is less the case in public markets.
Honestly, this is just based on my own intuition, but I'd argue top private market funds will continue to outperform top public market funds. If you want to account for "all" private market funds, you'll probably see them underperform most public market funds since there's so many shitty deals in the private space and public markets tend to have more competent companies.