Money Stuff: Private Indices Are the New Public Indices

I just feel like, within living memory, there were “public companies,” in which you could invest, and “private companies,” in which you couldn’t. I mean, someone could: Many private companies took no outside investment, but some did, and so if you ran the right sort of pool of capital and had the right connections you could end up with a collection of investments in private companies. But there was not a thing called, like, the “private market.” You couldn’t pick from a menu of big private companies and just go buy their shares. “Private companies” was not a clear unified category. There were startups with venture capital investments, and companies acquired by private equity in leveraged buyouts, and private partnerships of lawyers or doctors or investment bankers, and the odd large bootstrapped profitable private business, and thousands of local hardware stores, but there was no special conceptual connection between them.

What they were was not public. “Public companies” were a thing: US public companies are all subject to similar disclosure requirements, they trade on the same exchanges, they are open to all investors equally and they are often largely owned by the same few dozen big investment firms. There was something coherent about lumping all the public companies together, or comparing them to each other. In fact, you could go further and ignore the differences between them: You could say “ahh I can’t pick between the companies, I’ll just buy all of them.” This is, approximately, the theory of a broad market index fund: The stock index reflects the prices of all of the stocks, and an index fund allows you to buy all of the stocks and get the overall performance of the market. The stock market. The “public company” market. You just invested in all of the public companies.

“I’d like to invest in all of the private companies too” would have sounded insane. For one thing, how would you even know what they are? They’re not traded on the exchange, they don’t file with the US Securities and Exchange Commission, there is no readily available list of them, and there are at least millions of them. For another thing, they mostly won’t let you: At any given time, a few private companies are raising money, but most aren’t, and you can’t just buy their shares on the exchange whenever you want. For a third thing: Why? What thesis is served by investing in all the tech startups and LBO targets and law partnerships and hardware stores?

All of this has, over the course of my time in financial journalism, changed, and now it is absolutely normal for people to go around saying things like “ordinary investors should be able to invest in private companies too.” It is still somewhat incoherent, but it is, like, developing coherence. There is a growing category of private companies that are kind of like public companies. “Private markets are the new public markets,” I keep saying. SpaceX is brokering stock trades at an $800 billion valuation. In recent memory it would have been quite weird for a private company to (1) frequently broker stock trades between existing shareholders and prospective investors or (2) have an $800 billion valuation. Now, meh, whatever, the private companies are big and liquid too.

In, like, two years, the received wisdom in investing will be “you should own a low-cost broad market index fund that includes all the public companies and also all the private companies.” I mean, not all of them, not the hardware stores. But the large and growing category of private-is-the-new-public companies will be increasingly investable and increasingly indexed. The Financial Times reports:

Index provider MSCI has launched a global benchmark incorporating both public and private equities, as investors increasingly look to private markets to boost returns and diversify their portfolios.

The MSCI All Country Public + Private Equity index will allocate a 15 per cent weighting to private equity. It combines MSCI’s All Country World Investable Equity index, which contains 8,300 listed companies — 99 per cent of developed and emerging markets listed stocks — with a newly launched All Country Private Equity index. The latter tracks the valuations of 10,000 private equity funds globally.

The launches follow rapid growth in the private equity sector in recent years, with assets under management more than doubling to $4.7tn since 2018, according to consultancy Bain, despite concerns among some commentators over valuations being paid.

As private asset investments become increasingly widespread, MSCI expects more demand for a total equity benchmark.

“I would say that the lines around public and private equity are blurring,” said Luke Flemmer, MSCI’s head of private assets.

“Institutional investors increasingly view equity as a unified asset class encompassing both publicly listed and privately held companies,” MSCI said in a report about the index’s methodology.

“A total equity benchmark”! You can’t take that too literally; the hardware stores and lemonade stands won’t be in the benchmark. (Institutional private equity funds will be.) But there is increasingly a class of private companies that are blurring the lines between public and private, and why shouldn’t they be in an index?

A schematic story that I like to tell around here is that banks used to be in the business of taking deposits and making loans, but that business is risky, and they are moving away from it. Oh, not entirely. That is the core business of banking, after all, and they still do it. But at various margins, banking is getting narrower: Banks are putting less of their deposits to work in making loans, and more loans are being made by private credit firms with locked-up, long-term equity capital. (And banks are lending money to those private credit firms: The banks are “re-tranching,” taking more senior claims on the private credit firms’ pools of loans.)

We have talked about this change in business lending and leveraged buyout lending and project finance and trade finance. But what does it look like in consumer lending? Is there a story like “normal people used to borrow from banks, but now they borrow from private credit”? Well, we’ve talked about private credit investors buying mortgages. [1] But the simplest day-to-day version of the story is:

• Normal people used to buy stuff using credit cards. When you use your credit card to buy something, your bank lends you the money to pay for it.
• Now people increasingly use buy-now-pay-later loans to buy stuff. When you use a BNPL loan to buy something, some financial technology firm partners with a bank to lend you the money, but neither the fintech nor the partner bank has much of a balance sheet, and ultimately the loan is owned by someone else. Often the someone else is a private credit fund.

In this version, the modern rise of BNPL in the US is not so much a story of “fintechs offer a better user experience than credit cards” or “people are going into debt for burritos,” and more a story of “banks are retreating from consumer lending risk, and private credit firms, with their long-term capital, are better bearers of that risk.” 

At the Wall Street Journal, Telis Demos reports on this shift:

Private credit is exploding onto the scene in what is known as alternative consumer lending. Analysts at KBW tallied up new private-credit funding deals this year for financial-technology firms in consumer lending and estimated that those deals could support nearly $140 billion in lending globally over the next few years. That is a big surge from under $10 billion in 2024, the analysts estimated.

This lending includes things like buy now, pay later arrangements, as well as other kinds of personal loans.  …

Many banks that issue credit cards have sought to focus on higher-credit or wealthier borrowers. That has been reflected in part by shrinking card lending by banks: Across U.S. commercial banks, average balances on credit-card and other revolving consumer loans were down almost 2% in the third quarter from a year earlier, according to Federal Reserve data.

Demos’s particular point here is that this shift makes data worse: People are used to looking at bank data for information about consumer spending and credit quality, but if consumer loans are increasingly made by non-banks, the bank data is less informative.

That is one symptom of a more general effect of the move toward narrow banking, which is that banks are more regulated than non-banks. There is a reason for that: The classic bank business model, of taking short-term deposits and using them to make long-term loans, is quite risky. What makes it risky is not, like, “the banks are constantly making stupid loans”; what makes it risky is the funding model. (Silicon Valley Bank blew up by buying Treasury bonds; the risk was not in the bonds it bought but in the deposits it issued.) Everyone knows this and has known it for a century and there is a popular Christmas movie about it, so there is a lot of bank regulation to mitigate it. Some of that regulation takes the form “well, at least don’t make stupid loans”: Because the bank funding model is quite fragile, it is very important that banks make good loans, and be seen to make good loans, and tell their regulators about the loans they are making so the regulators can check.

It is considerably less important that private credit firms make good loans.  Still important! But bank regulation is driven by the particular funding risk of banks, and if loans are being made by non-banks those risks are lower and regulation will be lighter.

I sometimes like to imagine that humanity is capable of building an evil artificial superintelligence that will enslave or destroy us, and that we are foolishly blundering toward actually doing it, but we will be saved in the most trivial, embarrassing-for-humanity possible way. For instance:

• I have imagined a story “about venture capitalists building a runaway artificial intelligence that will likely enslave or destroy humankind, only to be thwarted by a minor poet suing them for copyright violations for scraping her poems.” 
• I have imagined a story about an artificial intelligence lab working on a project with a 20% chance of wiping out humanity, and then going to an insurance broker to price out insurance against that risk, getting a quote that it couldn’t afford and shelving the project. “And the evil omniscient demon inside your computer will say ‘ah drat,’” I wrote, “just before you pull the plug on him forever. And humanity will blunder on, saved from probabilistic extinction by the quiet heroism of insurance actuaries.”
• We once discussed Scott Alexander’s science fiction story “The Onion Knight,” about a malign superintelligence built to trade prediction markets: It takes over the world, but because it was trained to avoid onions (there is a famous little bit of US commodity futures regulation banning  onion futures trading), you could avoid being killed by the robots by tying an onion to your belt, which was the style at the time.

The theme here is something like: Humans are collectively brilliant and capable and reckless, and in theory we could build a computer that is even more brilliant and capable and reckless than we are. But we have lots of dumb little historically determined hang-ups, and in practice — or at least in an amusing science-fiction world — one of those hang-ups will hold the computer back from achieving perfect superintelligence.

I’m kidding! These are my dumb little sci-fi jokes. But here’s kind of an amazing Wall Street Journal article about OpenAI’s pivot to engagement:

When OpenAI CEO Sam Altman made the dramatic call for a “code red” last week to beat back a rising threat from Google, he put a notable priority at the top of his list of fixes. ...

OpenAI was founded to pursue artificial general intelligence, broadly defined as being able to outthink humans at almost all tasks. But for the company to survive, Altman was suggesting, it may have to pause that quest and give the people what they want. ...

And it was telling that he instructed employees to boost ChatGPT in a specific way: through “better use of user signals,” he wrote in his memo. 

With that directive, Altman was calling for turning up the crank on a controversial source of training data—including signals based on one-click feedback from users, rather than evaluations from professionals of the chatbot’s responses. An internal shift to rely on that user feedback had helped make ChatGPT’s 4o model so sycophantic earlier this year that it has been accused of exacerbating severe mental-health issues for some users.

Now Altman thinks the company has mitigated the worst aspects of that approach, but is poised to capture the upside: It significantly boosted engagement, as measured by performance on internal dashboards tracking daily active users.

Like: Sam Altman was apparently faced with a literal choice between working to make OpenAI’s models superintelligent, and working to make them give users answers that they wanted, and he apparently decided “ehh go for engagement.” Anyone who has ever looked at social media knows that “superintelligence” and “engagement” are opposites. Perhaps the intelligence of AI models is capped — not in computer science theory, but in commercial practice — at the intelligence of a social media feed. Maybe that’s even good news for humanity.

You know the rule: Every bad thing that a public company does is also securities fraud. Shareholders will argue that the company didn’t sufficiently warn them about the bad thing, they were tricked into buying the stock, the bad thing happened, the stock dropped, and they lost money, done.

“Bad thing,” here, means “thing that makes the stock go down.” On Friday, Netflix Inc. announced that it would buy Warner Bros. Discovery Inc. for about $82 billion; on Monday, Paramount Skydance Corp. jumped Netflix’s bid, and it’s possible that more bidding will come. Netflix’s stock went down about 2.9% when the deal was announced, and it went down another 3.4% yesterday when Paramount came in; I suggested yesterday that this might be because Netflix’s shareholders don’t want it to buy Warner and worry that it will keep bidding. And in fact the track record of big media mergers is, uh, mixed. It’s entirely plausible that Netflix’s decision to buy Warner is, in this context, a bad thing.

Can shareholders sue? I mean, traditionally, doing a merger is not securities fraud. There are limits to the theory. But Bloomberg’s Lucas Shaw reported this weekend:

When asked about a potential acquisition of Warner Bros., Netflix co-CEO Greg Peters echoed his former boss and mentor. “One should have a reasonable amount of skepticism around big media mergers,” he said at Bloomberg’s Screentime conference in October. “They don’t have an amazing track record.”

It’s true, Netflix wasn’t interested in most deals and had no interest in owning legacy cable networks. Peters’ dismissal led industry insiders to believe Netflix wasn’t interested.

Yet Peters’ public skepticism masked the company’s private intent. Netflix had already reached out to Warner Bros. and expressed an interest in the company and even gave the company a heads-up that Peters would dismiss a potential deal in public.

Hmm! “They don’t have an amazing track record” is true, and not exactly a denial, so not exactly misleading. But giving Warner “a heads-up that Peters would dismiss a potential deal in public” does sort of sound like an intent to mislead shareholders? And Netflix lost like 6% of its market capitalization in two days, or about $29 billion, which might be enough for an enterprising shareholder lawyer to sue over.

Of course, “everything is securities fraud,” as a theme, might be going away. We talked a few weeks ago about new guidance from the US Securities and Exchange Commission, which will no longer discourage companies from banning shareholder fraud lawsuits. Under the new guidance, companies can require mandatory arbitration of shareholder lawsuits, making class-action lawsuits impossible and making “everything is securities fraud” considerably less attractive for plaintiffs’ lawyers. [2]

It is not at all clear how significant this will be: State law in Delaware, where most public companies are incorporated, might not allow it, and companies might just be embarrassed to announce “if we do fraud our shareholders can’t sue.” But they might not be. It’s annoying that everything is securities fraud, and it might be preferable if nothing was, though ideally there would be some middle ground.

Anyway the Financial Times reports that a company did it:

An oil driller that uses biblical verses to guide exploration has become the first company to block class-action shareholder lawsuits under new management-friendly policies approved by US securities regulators.

Zion Oil and Gas, a penny stock that as of September had no revenue from drilling, said in a Securities and Exchange Commission filing last week that it would require shareholders to resolve disputes through arbitration rather than court. …

“It makes sense that a desperate company that’s been steadily losing money would want to block lawsuits from its shareholders,” said Tyler Gellasch, chief executive of advocacy group Healthy Markets Association. “What doesn’t make sense is why anyone would think that it would make investors want to give that company or its management more money.”

Here is Zion’s announcement. The stock is actually up a bit since the announcement. I have to say that, if you spend $0.18 to buy a share of stock of an oil driller whose “vision … of finding oil and/or natural gas in Israel … is based, in part, on biblical references alluding to the presence of oil and/or natural gas in territories within the State of Israel that were formerly within certain ancient biblical tribal areas,” but that has never actually found any oil, maybe you shouldn’t be able to sue if you lose money? You do kind of know what you’re getting into there. 

Kushner, Gulf money and desperate texts: inside Paramount’s hostile bid for Warner Bros. Behind Paramount’s Relentless Campaign to Woo Warner Discovery and President Trump. Warner Bros. Rival Bids Put Spotlight on Flagging Cable Networks. Supreme Court Appears Ready to Give President More Power to Fire Government Officials. Oil market faces ‘super glut’ as supply surge hits prices, Trafigura warns. Trafigura Boosts Trader Payouts After Another Bumper Profit. Abu Dhabi’s Hedge Fund Island Plans $16 Billion Expansion. Drugmakers Are Ditching Middlemen to Sell Directly to Patients. Activist behind Engine No. 1 Exxon campaign builds stake in Siemens Energy. PepsiCo to Cut Costs, Lower Food Prices in Deal With Activist. Now Cracker Barrel Diehards Think the Food Isn’t Up to Scratch, Either. A prediction market for shortform content. Swag gap.

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