Back to Drew's Views
June 7, 2022
Previous
Next

On the Disincentives of Investing in Public vs. Private Equity; and Implications for Pricing and Returns

Markets
Valuation

When stock markets are closed, that doesn’t mean there is never any change in the value of the thing you own.

This is true in public markets. Between the time that markets close until they open the next day, stuff happens. Earnings happen. Guidance happens. Takeovers happen. Prices change without flow. You find out how much they changed when they open.

Prices change with flow too.

And it is also true in private markets, where markets are basically closed for weeks or months and reopen occasionally. Prices change without flow.

Prices change with flow too, maybe.

So, private equity is equity. Yet, the lack of daily or timely marks potentially provides unrealistic comfort and a false sense of security to some investors. There is nothing necessarily terrible about this. We live in the world we live in, and in that world we have bosses and/or investors who don’t like volatility generally, and really don’t like it during certain types of environments.

Two years back, AQR's Cliff Asness even asked – perhaps in jest – if “multiyear illiquidity and its oft-accompanying pricing opacity may actually be a feature and not a bug.”

In other words, should illiquid securities be slightly penalized and require a higher rate of return in order to invest in them, or does their capability to mask underlying volatility in fact suggest they should or could require a lower rate of return? So, instead of earning an illiquidity premium, should they earn an illiquidity discount?

There is also an argument that when your hands are tied, you can’t hang yourself. As Cliff asked in that same piece, maybe “lock up periods keep investors from acting irrationally when markets become volatile?”

Again, I think Cliff wasn’t seriously suggesting that any of this should be the case, and instead was illuminating just how silly things were starting to become.

Indeed just this week, in a podcast with Morningstar and reported by Institutional Investor, he mentioned that the “big lag” in the pricing of private assets means that, yes, volatility might appear lower (or uncorrelated) in the short term, but eventually, we get there.

He called this “volatility laundering” – which I hope he trademarked – and tweeted (and I am paraphrasing):

‍“The amount people will pay to an industry to avoid daily S&P 500 volatility, all to generate returns that are similar in direction but lower than a moderately-levered S&P 500 Index fund...is staggering.”

Moreover, and again, this isn’t necessarily to say that PE managers are doing anything untoward, just that PE investors are playing this game, because the incentives are asymmetric.

Asymmetric for their bonuses, even their careers.

Where it potentially becomes most worrisome – which intrigues me greatly – is that this dynamic also (potentially) drives egregious PE valuations under certain paradigms, and/or within particular sectors.

So, if you are one of those PE investors enlightened enough to actually know your underlying volatility is being concealed, your next question should be if people are now paying too much for this camouflage?

In other words, just as the public markets can be affected by short term flows, is it possible that private market valuations, and the periodic marks of particular private investments, have been affected by increasing allocation tilts toward private equity?

The answer here may also help to reveal the relative unimportance of flows over the long term, yet the outsized impact of them in the short term.

Public equity is also equity, and eventually we get to the right price. We get to the right price for PE too (even without any flows, mind you) it just takes longer.

So maybe the fact that public markets can experience a bid-less vacuum amidst panic selling in March of 2020 implicitly overstates the volatility of listed equities in comparison to privately-held equity?

It sounds silly, I know, but no less silly than ignoring that a private equity framework implicitly understates the volatility of unlisted equities in comparison to publicly-held ones.

‍


Subscribe and sign up with your email address to receive the latest news and updates
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

FOOTNOTES

Download PDF

Topics

Markets
Valuation

DISCLAIMER

The views and opinions expressed in this post are those of the post’s author and do not necessarily reflect the views of Albert Bridge Capital, or its affiliates. This post has been provided solely for informational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The author makes no representations as to the accuracy or completeness of any information in this post or found by following any link in this post.

‍

YOU MIGHT ALSO LIKE

Text Link

Heading

Lorem ipsum dolor sit amet, consectetur adipiscing elit. Suspendisse varius enim in eros elementum tristique. Duis cursus, mi quis viverra ornare, eros dolor interdum nulla, ut commodo diam libero vitae erat. Aenean faucibus nibh et justo cursus id rutrum lorem imperdiet. Nunc ut sem vitae risus tristique posuere.

Text Link
Text Link

A Conversation between Drew Dickson and Morgan Housel

A discussion between Drew Dickson of Albert Bridge Capital, Morgan Housel of The Collaborative Fund; moderated by Jamie Catherwood of O'Shaughnessy Asset Management

Asset Pricing
Behavioural Finance
Markets
Read More
Text Link

Conversation with Dr. Daniel Crosby on his Standard Deviations Podcast

Drew joins Dr. Daniel Crosby on the Standard Deviations podcast.

Asset Pricing
Behavioural Finance
Markets
Sports
Read More
Text Link

Why European Stocks Might Win

In an op-ed for Marketwatch, Drew explodes the myth about European companies, and reveals where he thinks the opportunities are today.

Markets
Stock Picking
Valuation
Read More
Text Link

Finding Alpha in Europe

Drew and Toby chat about narrative-driven investing, Ben Graham's voting machine, behavioral explanations for stock mispricing, and managing a concentrated portfolio of investment ideas.

Markets
Behavioural Finance
Asset Pricing
Passive vs Active
Factors
Read More
Text Link

Sell in May and Go Away?

Turns out there may actually be something to the old Sell in May and Go Away adage - at least over the last 80+ years.

Markets
Asset Pricing
Read More
Text Link

If Growth Stocks Sell Off Will They Bring Value Stocks Down with Them?

Growth stocks crushed just about everything from 2017 through 2021. Not that they necessarily will, but if they do give back some or all of their gains, given their weightings, times will be tough for broader indices. But what about the value names within them, will they sell off in sympathy as well? Of course no one knows, including ourselves, but we take a quick look at behavior of value names as the tech bubble sold off from 2000 through 2002. This example may be worth some consideration.

Markets
Factors
Read More
Navigations
HomeTeamDrew's viewsPressContact
Disclaimers
Legal & regulatoryPrivacy policyCookies policy
How to get in Touch
info@albertbridgecapital.com

Subscribe to Drew's Views

No spam. Unsubscribe anytime.
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.
© Albert Bridge Capital 2022
Website by SW10media.com
homeTeamdrew's viewspressCOntactDisclaimers