In looking at the universe of investable assets, there are warning signs. Recently, JP Morgan CEO Jamie Dimon lamented that public companies currently number 4,300 in the US, down from 7,300 in 1996. He cited some of the reasons companies are hesitant to go public: “increasingly burdensome regulation, intensifying public scrutiny and a growing obsession with short-term financial results.”[1] The article highlights the growth in the number of companies choosing to remain private, backed by private equity.
We’ve previously noted that there seems to be too much private equity capital chasing too few good investment ideas. There are other problems dogging private equity. “The normal recycling of money through the venture capital ecosystem has dammed up like never before.” A slower initial public offering (IPO) market, meaning private firms going public, has made it “harder to raise money for new funds”.[2] Without “exits”—usually sales of portfolio companies or IPOs—the venture funds aren’t making distributions to their investors.[3]
Seeking to remedy the dearth of cash, private equity borrows. “Private equity firms eager to pay their investors are returning to an old habit: loading up companies with risky debt.”[4] As elections have consequences, a change in the regulatory climate and encouragement of entrepreneurial risk-taking may revive the IPO market and help to start increasing the number of public companies in the investable universe. Private equity may actually applaud this change of environment. We expect the US public financial markets to be a beneficiary of these changes and trends.
Are Non-US Markets Too Risky?
Outside of the US market, wouldn’t China, South Korea and the UK be good places invest? Recent news from China is that the government is trying to stimulate a sluggish economy. According to reports, China’s citizens and businesses are great savers. Productive investment of that savings could boost the Chinese economy. “Instead that capital has been forced to sit fallow or flow into real estate thanks to Beijing’s tight financial controls on the economy, favoritism for some industries and hostility to others—a matrix of conditions known as financial repression.”[5] Investing or staying invested in China would seem to require great care.
South Korea is also trying to “boost its stock market…but the country’s large family-controlled corporate empires, known as chaebols, could be an obstacle to more meaningful structural change.”[6] The list of issues preventing better treatment of minority shareholders in Korean companies includes: unwillingness to return capital to shareholders (dividends or buybacks), use of unretired treasury stock to maintain family control, use of convoluted corporate structures, and high inheritance taxes.[7] South Korea’s stock market looks likely to continue to be dogged by the historic Korea discount.
QMP has mentioned in the past (see Fall 2022 issue) the meltdown in the UK in 2022 which ousted then-Prime Minister Truss. We raise it again now as reports indicate that government insiders brought down the government,[8] rather than market reaction to moderate supply-side policy changes, as originally alleged in the press. Defined benefit pension plans are very tricky investment vehicles under current government regulation in both the US and UK, at least for private sector employees. From an investment perspective, it is always a balancing act between the asset side investment return, say the return on the S&P 500, and the growth of the discounted liability side, the obligation to pay pensions to retirees over a long period (which is calculated using a discount rate).
In the UK before 2022, “the Bank of England’s decision to suppress interest rates for an extended period had been terrible for defined benefit pension funds because low rates pushed up the present value of the funds’ long-term liabilities while suppressing investment returns.”7 The proposed raising of interest rates should have alleviated some of the strain; however, the funds’ managers had been hedging. This should sound familiar: the unintended consequences of convoluted, opaque investment structures. People used to lose their jobs. And the press used to report on the problem. Favoritism, insider mismanagement and failure to report make China, South Korea and the United Kingdom risky, perhaps too risky, for investment.
Within the US, financial market advice from a retiring CFO of a public company to his successor seems relevant. “As a public CFO, everybody wants you to invest, but they don’t want you to take your earnings down. And that is a really tricky box to be in. It’s possible, but you just have to time things out in a way that that all works, and that gets very, very tricky.”[9]
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William H. Darling, Chairman & CEO