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Differences between public markets and private markets

Apr 25, 2023

Securities make up a growing proportion of transfers around the world, yet the majority of them are difficult to trade since the ability to sell depends on the market they’re traded in. 

There are three primary types of securities: equity, which grants ownership rights to holders; debt, which involves loans that are repaid through periodic payments; and hybrids, which blend features of both debt and equity.

Investors can access securities through two types of markets: the public market and private market, and both act as a way for companies to finance themselves as well as a medium for investors to invest their capital.

While both are essential to the global economy, they differ significantly in terms of accessibility and structure.

The key differences between public and private markets

The current differences in the public and private markets have been defined by regulations, investor access, and liquidity.

The Securities and Exchange Commission (SEC) over its nearly century-long history has developed and refined clear guidance on the process of investing and trading public market securities. Securities issued in the public markets typically require substantial public disclosure through expensive and time-consuming filings with regulators. In order to issue and maintain a public market security, companies are required to disclose information about their financials, revenues, and performance while remaining accountable to their shareholders.

The massive number of investors interested in participating in the public markets has grown over time which has invited more intermediaries who have contributed technological advances to drive speed and security, enabling trading volumes to flourish.

Private markets seemingly haven’t had the same level of oversight. Private market securities generally require less SEC documentation, and typically only for fundraising activities. This, in turn, makes it less expensive and time-consuming for private companies to raise capital. However, this reduced level of oversight is also seen to be more risky for individual investors, which the SEC aims to protect from unknown investment risks.

Exploring the world of public markets

For centuries, public markets have played a vital role in the global economy, providing investors with opportunities to buy and sell securities. Among these markets, one of the most iconic is the New York Stock Exchange (NYSE), which has been operating since its founding in 1792. Today, the NYSE stands as the world's preeminent stock exchange, with over 2,400 listed companies and a total market capitalization exceeding $2.6 trillion.

Public markets such as the NYSE, NASDAQ, and Tokyo Stock Exchange enable investors to trade a wide variety of securities, including stocks, bonds, and ETFs. Meanwhile, exchanges like the CBOE, ICE, CME, and LME offer trading in options, derivatives, and physical commodities, further expanding the scope of investment opportunities available to market participants.

The benefits of public markets

For investors

Liquidity is a key factor for investors in the public markets as it enables easy buying and selling of assets, translating into faster access to capital, greater price discovery, and the ability to realize profits more quickly.

Another advantage of public traded securities is their accessibility. These are often available as a lower-cost investment option and open to the general public, providing opportunities for a wide range of investors to participate in the stock market.

Moreover, public markets offer a high level of transparency and regulatory oversight, which ensures that investors have access to accurate and timely information. 

Public markets also offer the potential for high capital gains. When a company's stock price rises, investors can sell their shares at a profit. Additionally, many public companies like Apple, Microsoft, or Tesla pay dividends to their shareholders, providing an additional source of income to investors.

Lastly, investing in public markets allows investors to diversify their portfolios across a wide range of asset classes, industries, and geographies. A well-diversified portfolio helps in reducing exposure to individual company risks and potentially earns better returns over the long term.

For companies

By going public, companies can raise substantial amounts of capital through an IPO and subsequent funding rounds. This influx of funds can provide the financial resources companies need to expand their business and pursue new opportunities.

Shares that trade on a public stock exchange have more liquidity than privately held shares. This increased liquidity can lead to a higher share valuation and stock price for the company, which can enhance its market capitalization and increase the perceived value of the company in the eyes of investors.

In addition, when a company goes public, it generates a lot of publicity, which can help to raise its profile and make its products and services more widely known. This can be particularly beneficial for companies looking to expand their market share and reach new customers.

The challenges of public markets

For investors

One of the most significant drawbacks of investing in public markets is volatility and market fluctuations. The stock market can be highly unpredictable, and stock prices can fluctuate dramatically in response to a wide range of factors, including economic indicators, geopolitical events, and company-specific news. This volatility can make it difficult to achieve consistent returns and may lead to significant losses if not managed properly.

Investing in public markets may also result in limited control over investment decisions. While investors can choose which stocks or securities to buy, they do not have control over the management or decision-making processes of the companies they invest in. 

For companies

One of the most significant changes that takes place once a company goes public is the increased disclosure requirements for investors. Increased disclosure requirements for public companies can be challenging, requiring significant time and resources to prepare and file the necessary documents. Smaller companies may struggle to comply with regulatory requirements and face fines or other penalties for noncompliance.

In addition, the process of conducting an initial public offering (IPO) is time-consuming, often taking several years before the company can officially list on the public market. It requires significant attention and resources from the company, which may divert management's focus from other important tasks and impact day-to-day operations.

Exploring the world of private markets

The private markets are not as widely known or talked about, in large part due to the fact that many U.S. residents are excluded from participating. The first words that often come to mind when thinking about private markets are pre-IPO “unicorns” and the lead-up to the initial public offerings (IPOs), but there is a lot more to the private markets than this.

Similar to public markets, the private markets encompass various asset classes such as equity, debt, real estate, and funds, also known as alternative assets. However, private markets differ from public markets in that they lack strict regulations for companies seeking financing and disclosing information publicly. Instead, companies have the freedom to choose their preferred financing sources and terms.

The growing prominence of private markets is a result of fundamental changes in financial intermediation that can be traced back to the 1980s. These changes originated in the United States and arose from shifts in the business practices of banks and the role of public markets. Private markets, following their success in the United States, began to emerge in other regions of the world.

With almost $11,7 trillion in global assets under management (AUM), private markets represent a significant share of the financial industry. While North America and Europe are the largest markets for private funds, Asia has its own mix of specializations. 

Private equity (PE) and real assets are the dominant sectors in North America and Europe, each representing about 40% and almost 30% of the AUM, respectively. However, in Asia, venture growth capital (VGC) accounts for half of the assets, while private credit (PC) is comparatively smaller.

Despite these regional differences, the demand for exposure to private market assets remains high across all jurisdictions. In early 2021, dry powder, or commitments made by investors that have not been disbursed, stood at about $3 trillion overall. This represents about 40% of PE assets in North America and Europe and approximately 30% of VGC assets in Asia, suggesting a significant untapped capital commitment.

Private market funds tend to invest in different industries, with PE traditionally focused on less cyclical sectors with more resilient cash flows, such as information technology, business services, education and healthcare, and financial services. 

On the other hand, VGC is heavily tilted towards the more innovative areas of the economy, with information technology accounting for about 40% of the global portfolio. Meanwhile, private credit's industry portfolio is diversified in a similar manner to that of PE, but with a lesser proportion allocated towards construction and real estate.

Private markets have become a comparable force to the traditional part of the financial system, with private investments surpassing portfolio flows to emerging market economy (EME) corporate assets since the mid-2010s. 

Furthermore, private investments have matched syndicated lending to EME corporates and have started to approach the volumes of gross foreign direct investment flows.

The benefits of private markets

For investors

One key advantage of privately traded securities is their flexibility as well as the diverse range of investment options, including direct investments in private companies, real estate, and infrastructure projects. 

Another notable advantage of private investments is their potential for stable valuations and low portfolio volatility, due to the lack of exposure to the market fluctuations that can affect publicly traded companies. With no daily price movements to contend with, investors may experience a reduced risk of sudden losses stemming from market volatility, which can foster a sense of stability and consistency. As a result, private investments may be an appealing option for those seeking to maintain a more predictable investment portfolio over the long-term.

Privately traded securities can also provide investors with access to high-growth innovative and disruptive companies that are not yet available for public investment. Private equity firms, in particular, specialize in financing startups and early-stage firms that possess unique business models and cutting-edge technologies, which may unlock significant value over time.

For companies

One important advantage to consider is that private markets have fewer regulatory compliance requirements, which can save companies both time and money.

Another significant advantage of being a private company is greater privacy. Unlike public companies, private companies aren't required to disclose as much information to the public, allowing them to operate with more privacy and autonomy. This can be particularly appealing for companies that are sensitive about protecting their intellectual property or other trade secrets.

Last but not least, a private company has the ability to make decisions that are driven by the owners' preferences, rather than the demands of shareholders. In contrast, public companies have a fiduciary responsibility to act in the best interests of their shareholders. This can sometimes mean that they are forced to make decisions that are not aligned with the long-term interests of the company or its founders.

The challenges of private markets

For investors

One of the potential drawbacks of privately traded securities is that they can be less liquid than public ones, which means it may take longer to sell an investment or get access to your capital. 

Additionally, there may be less information available about private market investments compared to publicly traded assets, but many investors work with experienced advisors or consultants to help mitigate these concerns.

Another consideration that is frequently discussed in the context of private market investing is the potential for higher risk due to the lower level of regulation and oversight. However, this should not be misconstrued to suggest that private market investments are intrinsically riskier than public market investments. On the contrary, private investments can offer investors unique opportunities to capitalize on innovative and disruptive companies that may be overlooked or undervalued by public markets. 

With a robust due diligence process and thoughtful risk management strategies, investors may be able to mitigate the risks and capture the potential rewards of private market investing.

For companies

Staying private can limit liquidity for existing investors, as they are unable to easily sell their stake in the company through a public exchange. This can be particularly challenging for lesser-known companies, as potential buyers may be limited to existing owners.

Another aspect to take into consideration is that funding can be a significant hurdle. Unlike public companies, private companies have a smaller pool of potential investors to draw from, which can limit their access to capital. 

Factors to consider when choosing between public and private investment

When weighing the pros and cons of investing in public versus private markets, investors should take a nuanced approach and consider multiple factors.

One critical aspect to weigh is their personal risk tolerance, as private market investments may be riskier due to the lower level of regulatory oversight and transparency. Investors should carefully evaluate their individual risk appetite and determine which type of investment aligns with their objectives and overall portfolio strategy.

Additionally, liquidity needs are important to consider. Immediate liquidity needs may require investment in public markets, while delayed liquidity needs may be better suited for investors in private markets. 

Investors should also take their investment experience and knowledge into account when considering their options, as private market investments may require more expertise to assess risks and returns.

In addition to assessing factors such as risk tolerance, liquidity needs, diversification, and investment experience, investors should also stay up to date with the future prognosis of public and private markets.

For instance, a report by Hamilton Lane, suggests that private markets, particularly infrastructure and secondaries, present areas of opportunity for investors in 2023, despite the challenges of the previous year.

Investors may be able to benefit from investing in private companies that are focused on consumer-driven markets, as these companies may have a strong potential for growth and profitability.

The secondary market, in particular, is experiencing more supply than demand, which is leading to decreasing prices and innovation around exits and liquidity options. It's also worth noting that retail investors now have expanded access to private markets products, with a few large players dominating the space, but this concentration may decrease as more managers enter the market, as has happened with private equity in the past.

Creating access and efficiencies in the private markets

With limited access and historically smaller institutional participation when compared to public markets, the private markets have been more illiquid and highly manual for both companies and investors to trade in. But as with most things, the increased awareness of the private markets potential has garnered more demand, opening the door for change. This change is driven by three main factors: private market growth, technology, and greater regulatory oversight and clarity.

Today, the U.S. private market is larger than the public market, with statistics showing that public markets have raised $1.4 trillion in capital for issuers, as opposed to the nearly double $2.9 trillion in capital raised in the private markets.* It is also believed by some investors that there is greater upside potential in a private market security than a public market security.

Although private markets are larger, they have been very illiquid in comparison to the public markets, and as a result, institutional investors often hold their private market investments to maturity (think: years).

When looking at trading volumes you’ll see a large discrepancy between the two markets. Public markets see $33 trillion in annual trades, whereas private markets only see $100 billion (or $0.1 trillion) in trades, and that’s where improvements in technology and oversight are expected to be game-changers.*

In the most recent years, the SEC has introduced changes to make the private markets more accessible to individual investors and to make fundraising from a broader group of investors more accessible to private companies. They’ve done this through new regulations, such as Regulation Crowd Funding (CF) CF, Regulation A+ (also called the mini-IPO) and others, which allow accredited individual investors - and some retail investors - to participate.

Along with these changes in regulation is also the introduction of the blockchain and companies like Securitize leverage decentralized ledgers to issue and record ownership for private market securities. These newer companies are different from the intermediaries in the public markets in that they are operating on the latest technology, which enables them to offer a single, fully-digital process that makes it possible for trade settlements to occur within the same day as opposed to days or weeks (like the public and secondary market). 

Advances by companies like Securitize are enabling liquidity in both primary and secondary markets, answering the overwhelming demand for access, transparency, and security.

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