India has more unicorns than is normally appreciated, analysts at Credit Suisse pointed out in the firm’s recent Asian Investment Conference. One of the big enablers, they said, has been the surge in access to private capital. In the past three years, fundraising by Indian firms in the private market averaged $34.5 billion, more than double the $15.1 billion raised on average in the public markets. A decade ago, the two sources of funds stood neck and neck, according to VCCEdge data quoted by the brokerage firm.
The growth of private capital is a global phenomenon and has accelerated since the global financial crisis. As more institutional and high networth investors seek higher returns available in these markets, opportunities in the public markets will be fewer, said analysts. Individual investors, who don’t have access to private capital markets, evidently suffer as a result.
“There is a natural shortage of risk capital in an economy with low per capita wealth. However, this has been addressed by a surge in (mostly foreign) private equity,” said Neelkanth Mishra, co-head of Asia-Pacific strategy and India equity strategist, Credit Suisse. There is a sort of a virtuous cycle, where those who have gained wealth because of the private market will reinvest gains in the same market, because of their positive experience, he said in the report on unicorns. However, what is a virtuous cycle from the perspective of takers of capital could well be a vicious cycle for individual investors.
One outcome of the surge in private capital is that firms have the luxury of waiting much longer before accessing public markets. The median time taken by a firm to make an initial public offering (IPO) has risen by around 50% in the US in the past two decades, Michael Mauboussin and Dan Callahan of Counterpoint Global pointed out in a report on the shift to private equity last August. Counterpoint is a division of Morgan Stanley Investment Management.
The upshot: “A consequence of staying private longer is that more wealth is created in the private market and less in the public market,” said Mauboussin and Callahan. They gave the example of Amazon.com, which went public just three years after it was formed. As a result, nearly all of the wealth created by the firm was in the public market. At the time of its IPO, Amazon had a market capitalization of $660 million. This has risen 2,275 times.
The value created in the public markets diminishes for companies that take longer to hit the public markets. The market cap of Facebook, which took five years more than Amazon to go public, has risen by around seven times since listing. Public market returns of Uber, which had the luxury of waiting for 10 years to list because of the private capital it raised, have been much lower.
For some firms, of course, an IPO may never ever see the light of day. Alliance Tire Group is often cited as a great success story in the private equity space. First, Warburg Pincus sold its stake to KKR & Co. Inc. at a handsome profit after holding it for about six years. After three more years, the latter sold the stake at a neat profit to Yokohama Rubber Co. Ltd, a Japanese maker of passenger-car tyres. Great value was created by an Indian entrepreneur who partnered with PE firms in acquiring and growing the firm, but the public markets never got to participate in this wealth creation.
Of course, going public brings with it greater scrutiny and the burden of greater compliance. This means some firms may never go public.
Another trend seen in the US is that of investors seeking higher returns in private markets shifting to low-cost products in the public markets. “Since 2008, investors have directed $2 trillion into index mutual funds and exchange-traded funds and moved more than $1.8 trillion out of active funds. Many institutions are satisfied with gaining exposure to the risk and reward prospects of public markets at a low cost and seeking excess returns in private markets,” said the Counterpoint Global researchers.
This trend appears to be beginning to play out in India as well. Traditionally, flows into actively managed equity funds track trailing returns. However, in the past few months, though returns have been decent, there have been large outflows from Indian funds. This is largely because of underperformance vis-a-vis benchmark indices, said analysts. Data from Morningstar shows in large-cap, large-and-mid-cap, multi-cap and tax-savings categories, only 11-26% of funds outperformed the benchmark in the past five years. It almost seems foolhardy to not have allocation to passive funds at lower costs.
Given the recent underperformance, some financial planners have also encouraged individual investors to increase exposure to overseas passive investing funds.
Could individual investors get access to private markets? Vanguard, which lowered costs and improved access to public markets for individual investors, announced last year that it is providing access to a portfolio of private equity and venture capital funds for accredited investors. The eventual aim is to increase access and provide the product to other individual investors as well.
It could be a long while before anyone is allowed to take similar steps in India, given the traditional view that individual investors are unsophisticated and should be kept away from markets that are less regulated.
For now, the investment avenues for individual investors are shrinking.