Posted on October 4, 2021 by Scott Shuda
The latest episode of Goldman Sachs’ Exchanges at Goldman Sachs looks at the rise of investment by traditional public market investment entities, specifically hedge funds, in private equity and venture capital companies.
“We’ve observed an acceleration of activity in private markets among our hedge fund clients. So, we wanted to understand the key drivers and the implications on our industry. We believe there is a confluence of factors at play here. And the first is that there’s been a pretty significant shift in the capital formation process for companies.”
I focused on three reasons, presented within the podcast, for this trend. The first is simple, there’s a lot of money to be made in private companies – the cream of the crop are appreciating even faster than public market companies.
“One of the best ways to exemplify this is by looking at the number of unicorns or private companies that are valued at over a billion dollars. There’s almost 400 of these companies today versus just nine a decade ago. And it’s pretty stunning that 155 of these attained that status just in the first half of this year alone…the five-year growth rate for private equity and venture capital as an asset class has doubled that of hedge funds. So, all of these factors combined, certainly, have led a lot of our hedge fund clients to spending a bit more time looking at privates.”
The second reason relates to when private companies chose to go public, and the tendency to see even higher prices follow as a result of that event.
“I think there’s been the strong IPO pop phenomenon, by which we mean the tendency of IPOs to outperform in the days or weeks after IPO…with the IPO pop, there’s a lot of incentive to get an allocation to an IPO, which is a competitive process. So, investing before that point definitely gets you in a better position to secure an allocation to the IPO.”
The third reason that particularly resonated with me, is the portfolio stabilization effect of holding private companies.
“And then lastly, we talked about performance dimension. One other dimension to the performance question is around volatility. So, if you’re a hedge fund and you have privates inside your hedge fund vehicle, you actually get the volatility dampening effect or the sort of smoothing effect of not marking to market your private portfolio on the same rate as you do your public portfolio, which obviously gets marked on a day-to-day basis as the markets go up and down. So, there’s a sort of natural smoothing effect, which I think allocators appreciate.”