Private Equity Changes Everything

The growth of private equity is “one of the most profound shifts in the capital markets since the 19th century,” according to a new EY report.

Illustration by II

Illustration by II

Private equity is too big to ignore — for both investors and regulators.

“It’s critical,” said Peter Witte, associate director of Ernst & Young’s private equity group, in a phone interview. “If you’re not invested in private equity, or private capital, then you’re really missing out on where our economy is growing.”

Private equity firms now manage $3.4 trillion of investor commitments globally, up from less than $500 billion in 2000, according to a report, expected to be released Wednesday, from EY and the Kenan Institute of Private Enterprise at the University of North Carolina at Chapel Hill. Citing Preqin data, they said private capital assets have risen to $6 trillion, including infrastructure, real estate, private debt and natural resources.

At the same time, the pool of publicly traded companies in the U.S. has shrunk by almost half in the past 20 years, according to the report, which cited data from The World Bank. Companies backed by private equity firms employ almost nine million people in the U.S., the report shows, underscoring their broad and growing reach in the economy.

“We’re in a place now where private equity firms have a super abundance of capital,” said Witte. “As more capital flows into private equity, or private capital, there’s naturally going to be a more important role for regulators to play.”


[II Deep Dive: Private Equity Seeks Almost $1 Trillion Globally]

Witte declined to comment on the private equity reform that Elizabeth Warren, the U.S. Senator and Democratic candidate for President, has proposed under the “Stop Wall Street Looting Act.” Warren announced the bill in July, raising concerns about the potential for bankruptcies and job losses when private equity firms load companies with debt to increase their returns.

Regulators could have a role in opening private equity to ordinary investors, said Witte, adding that the Securities and Exchange Commission is evaluating ways to give them access to private markets. While institutional investors such as pensions and endowments have long locked up their capital in private equity funds, average investors don’t have such access.

“There is a liquidity trade off,” he said. “That is why private capital has been limited — at least so far — to large sophisticated investors.”

Firms have experimented with structures that might allow private equity to make a breakthrough in 401(k) plans, where trillions of dollars are invested for retirement savings, according to Witte. In the meantime, many large and wealthy investors are planning to increase their allocations to private equity in hopes of finding returns that beat public markets.

About two-thirds of institutional investors have exposure to private equity, allocating an average 10 percent of their portfolios to the asset class, according to the EY report. A “modest shift” among existing investors could result in “significant additional inflows” to private equity, the report said.

Households, including family offices, wealthy individuals and ordinary investors, could really move the needle on inflows to private equity. Moving a mere one percent of their total equity holdings to private equity would translate into $149 billion of capital for the alternative investment industry, the report showed.

Private equity firms use different strategies, raising funds that invest in early-stage venture capital deals, growth capital strategies, and large leveraged buyouts. Companies can also turn to private equity firms as lenders, as seen in the growth of shadow banking over the past decade.

“We’re in the middle of this shift in the way that companies are getting funded,” Witte said. “Companies can spend more of their lifecycle on the private side.”

The boom in private equity is coinciding with stagnation in the public markets. The report described the growth as “one of the most profound shifts in the capital markets since the 19th century,” when public equity markets became widely accessible to investors and companies.

“It’s become increasingly clear that the model of public ownership is increasingly falling out of favor, at least for many companies in the middle-market space and those in the more growth-oriented stages of their maturity curves,” the report said.

While some businesses fare well under the scrutiny of a large shareholder base in public markets, others are better suited to private equity owners who can fund “transformational changes” beyond the public eye, Witte explained.

“It really boils down to who’s the best owner for a particular company or asset,” he said.