Money Stuff: The New Market Is Public-Private

Historically, one thing that distinguished private markets from public markets was that the private markets were smaller. Everybody could buy public stocks, but most people could not buy private companies. Firms that did private investing did not have or need mass distribution: They had perhaps dozens of clients, institutions and rich families, who invested with them; they didn’t go looking for $1,000 checks from thousands of individuals. 

Meanwhile firms that did public stock investing — mutual fund companies, etc. — did often have thousands or millions of clients, often with pretty low investment minimums. And they had the infrastructure to handle all those clients. They had customer service departments that could handle millions of accounts. They had relationships with financial advisers who put retail clients in their funds. They advertised.

All of this stuff has become very blurry in recent years. Private investment firms — particularly the big publicly traded alternative asset managers — have become huge and increasingly want everyone’s money to continue growing. The legal distinctions between public and private markets have become less important: In the US, firms can sell private assets only to “accredited investors,” but the bar for being accredited is low enough that now roughly 18.5% of US households qualify, versus about 21% of households that own public stocks. So the retail audiences for public and private investments are roughly the same size.

Meanwhile the big public stock investors — the mutual fund companies — are in a business that is, increasingly, solved. Public stock markets are pretty efficient, in the sense that it is difficult for a professional to reliably beat the market. If you want public stocks, you can get an index fund that will buy the market for you for an annual fee of perhaps 0.03% of your assets. A professional mutual fund manager will have a hard time outperforming the index fund, which makes it hard for the manager to charge a lot more. 

The private managers, though, can charge a lot more: Private markets are less efficient, and if you are a private equity or venture investor selecting and negotiating deals with individual private companies and then helping to operate those companies, you have much more opportunity to make outsized returns. And there is no equivalent of indexing in private markets, so there is less pressure on fees.

If you are a public mutual fund manager, this can be a discouraging situation. But you do still have some useful assets, like your relationship with financial advisers and your capacity for customer service. Private fund managers who have dozens or hundreds of institutional clients are now looking to sign up millions of dentists, but they do not have the sales force or capacity to do it. Public fund managers do. There are deals to be done.

Those deals might be mergers or acquisitions, but there are other possibilities. The Financial Times reports:

Capital Group and KKR are set to launch new funds spanning private loans, corporate buyouts, and infrastructure and property deals in the latest tie-up between big traditional asset managers and private capital firms.

Los Angeles-based Capital Group — the world’s biggest active asset manager — and private equity giant KKR have agreed to jointly offer a wide range of funds for individual investors that will mix traditional stocks and bonds with unlisted assets such as corporate takeovers.

The groups will launch their first two debt funds on Tuesday, and offer strategies combining listed stocks with buyouts as soon as 2026, in addition to other funds dedicated to real estate and infrastructure, top executives from each company told the Financial Times.

Alternative firms are racing to manage money for private individuals who have minimal exposure to unlisted assets, compared with pension funds, which have significant private market exposure. Meanwhile, traditional investment houses are keen to push into private markets, which hold the potential for higher returns but often carry greater risks and fees.

“But often carry greater risks and fees”? The fees are the point. Public markets are solved, so the fees are compressing to zero. Private markets are where the fees are.

Here’s the Capital/KKR press release, which emphasizes Capital’s distribution:

"Our partnership extends beyond products to the power of financial advice. Capital maintains relationships with more than 200,000 financial advisors across the United States. We have an opportunity as a trusted partner to help advisors deliver this significant advancement in our industry to their clients. We've built a knowledge platform to aide with understanding the category and are providing the tools needed to build client-centric portfolios using these strategies," said Matt O'Connor, CEO of Capital Group's Client Group.

And future moves into private equity:

"Expanding access to private markets is much more than two public-private credit solutions. A joint, cross-company project team is already working on public-private equity solutions. We're discussing how we can bring public-private model portfolio solutions to our clients," said Gitlin. "We believe there is a role for private market solutions in retirement, including target date strategies. We're working on the best way to bring public-private solutions to clients outside the U.S. And we're also seeing how Capital Group can work more closely with KKR to support their insurance business. Needless to say, there's a lot going on as we partner to build this category and best serve our clients," [Capital CEO Mike] Gitlin added.

We have talked a lot over the years about the idea that “private markets are the new public markets”: Big companies stay private longer, they raise billions of dollars at hundred-billion-dollar valuations in private markets, employees and early investors can get liquidity without going public, private credit is a competitor to public credit markets, etc. You can tell fundamental stories about why this shift has happened: More wealth is concentrated in the sorts of investors who can invest in private markets, globalization and technology make it easier to access that capital, and regulation and disclosure and shareholder lawsuits have made public markets less attractive to companies.

But a dumber, more cynical version of the story might be: Financial intermediaries get paid a lot more for managing private assets than they do for managing public assets, so they prefer private assets. If you run a successful private startup and you are considering an initial public offering, you might go to Goldman Sachs Group Inc. for advice, and the chief executive officer of Goldman Sachs will literally tell you “it’s not fun being a public company” and “who would want to be a public company?” Quite possibly he is correct! But in the past, the CEO of Goldman Sachs was in the business of telling companies to go public, because that’s how Goldman Sachs made money. Now Goldman is an alternative asset manager, sort of, and the money is in private markets. If you are a company looking to raise money, you will deal with financial intermediaries — banks and asset managers — and if they all say “private markets are the way to go,” you might stay private.

And if an increasing share of the economy — and particularly of the fastest-growing and most valuable firms — is in private assets, investors can’t just index. You can’t get “the market return” by buying every public stock if half of the market is in private companies. You have to buy a mixed public-private fund, and pay for it.

One general theory you could have is that there are a lot of businesses whose managers are good at doing their business, but not great at business generally. There are lots of pest control companies owned and managed by people whose background is in pest control, who are very good at killing cockroaches but mediocre at marketing and capital planning and fundraising and personnel management and mergers and acquisitions. If you added general business skill to those companies, they would be worth more. 

The simplest implementation of this theory is management consulting: Management consulting firms employ smart people with general business knowledge, which they rent out to actual companies for a fee. If an inefficiently managed company is worth $100 million, and it hires consultants who charge $2 million but make the company worth $150 million, then the company is getting a good deal.

The more important modern implementation of the theory, though, might be private equity: Private equity firms employ smart people with general business knowledge, and then they acquire inefficient companies cheaply, apply their general business knowledge, make those companies more efficient, and capture the upside for themselves. If an inefficiently managed company is worth $100 million, and it gets acquired by a private equity firm that makes it worth $150 million, then the private equity firm is getting a good deal: Instead of charging $2 million for its general business expertise, it earns $50 million. [1]

A further refinement of the theory, which we discuss a lot around here, is the search fund, which is like private equity except (1) instead of a big firm it’s one recent business school graduate and (2) the deals are usually smaller. If an inefficiently managed pest control company is worth $5 million, and a recent Harvard Business School graduate buys it for $5 million that she raised from friends and family and uses her MBA to make it worth $10 million, then that’s a good deal for her, which is why so many people with prestigious MBAs keep going into pest control.

Each of these implementations — consulting, private equity, search funds — implicitly assumes that smart young people can have general business skill, that graduates of prestigious business schools or investment banking analyst programs or consulting firms actually have an ability to add value to the businesses they touch. They also assume that that talent is somewhat scarce, that there are only so many McKinseys or KKRs or recent Harvard MBAs, so they can earn economic profits.

One plausible interpretation of modern artificial intelligence is that you can go to a computer and ask it to optimize a capital structure and it will do a pretty good job, but if you go to a computer and ask it to kill a cockroach it will do a pretty bad job. And so you can replace the consultants, private equity employees or search-funders in this model with AI, and use AI to make the pest control companies better-managed and more valuable, though you still need someone to go kill the cockroaches.

As with consulting, you could imagine doing this on a fee basis — charge the pest control companies $1 million to make them more valuable, etc. — but, as with private equity, probably the more lucrative way to do it is on a principal basis: You buy the pest control companies, put an AI in charge, make them more valuable, and keep the extra value for yourself. 

I suppose this implementation is called “venture capital.” The New York Times reports:

Thrive Capital is raising money for a company it has created called Thrive Holdings, which is meant to develop and buy start-ups, according to four people with knowledge of the matter. The idea is to help operate the businesses, and use the cash flow to both invest in the companies and buy up others. …

Thrive Holdings appears to be particularly interested in everyday industries. Thrive Capital has already backed two companies that fit this mold: Crete, an accounting company, and Long Lake, which has focused on buying managers of homeowner associations. Thrive Holdings has already started investing in complementary areas, such as I.T. service providers, these people said.

Other venture capital firms have publicly committed to a serial acquisition strategy, known in the finance world as a roll-up. General Catalyst, for example, explicitly promoted its plan to support “A.I.-enabled roll-ups” when it led a fund-raising round for Eudia, an A.I.-enabled legal services company. (It has also invested in Long Lake.) Others betting on a similar strategy include the firm 8VC.

The idea is these businesses can be made vastly more efficient by incorporating A.I.; Long Lake, for example, uses such software to automate the operations of homeowner associations.

But unlike roll-ups done by Wall Street mainstays like private equity firms, the venture firms are targeting younger companies. Thrive Holdings also plans to focus heavily on the operations of the businesses it buys, in part by using a team of software engineers and Thrive’s ties to A.I. companies like OpenAI, these people said.

Thrive Holdings also differs from other venture firms via its setup as a so-called holding company that can own stakes in companies for a long time, even “forever,” one of the people with knowledge of the company said.

We have talked about Long Lake before. I wrote:

With a sufficiently general-purpose technology it’s not clear whether the value will mostly accrue to the builders of that technology or to its users. But surely it is at least plausible that AI will mostly make its users richer, so the way to bet on AI is mostly to bet on regular, non-AI companies that don’t use it yet but eventually will. 

So you buy various boring businesses that could be more automated, then you automate them. (Or I suppose you buy boring businesses that can’t be all that automated — pest control, etc. — and use AI to automate the management and marketing of those businesses.) If operating a business is a good job for AI, then the business you should be in is acquiring businesses and turning their operations over to AI. The most general business skill, in this model, is knowing where to put the AI.

I mean, the other general business skills are things like “sourcing and negotiating acquisitions” and “raising a permanent capital vehicle to do these deals,” which I suppose still requires humans, but for how long? Perhaps the AI can handle all of the financial and business stuff, and all the humans have to do is the actual work.

The main thing that most shareholders want from public companies is for their stocks to go up, but some shareholders also want other things. For instance, you might want the companies that you own to minimize their use of fossil fuels, or to maximize it, or to pursue racial and gender diversity, or not to. You might have a stock-price-going-up rationale for these preferences — you might think that diversity is good or bad for performance, or that climate change is or is not an important long-term financial risk — but you don’t have to. You could just care about climate change or diversity for their own sake. Shareholders are people too, and people can have preferences that go beyond making more money.

This is true of shareholders who are literally people — individual investors — but also of many sorts of institutional shareholders. Some shareholders are, for instance, public pension funds of states governed by Republicans or Democrats, and the managers of those funds might have political preferences that are not simply about maximizing returns to pensioners. [2]

So there is a real market in helping shareholders express personal opinions about companies. Bloomberg’s Jeff Green reports on Bowyer Research:

Roughly 400 miles from Wall Street in a small town in Pennsylvania’s Rust Belt, Jerry Bowyer, his wife and five of their children have been working around a dining room table, sifting through corporate data on hot-button issues such as abortion, DEI and climate change.

Their goal: Shift more power to conservative investors at company annual meetings. And, with the 2025 proxy season kicking into gear this month, there are signs that the Bowyers are winning some converts.

Institutional Shareholder Services Inc., which influences how millions of shares are voted each year, offers Bowyer Research’s guidelines among its categories for voting. Egan Jones, another advisory firm, is doing the same for the first time this year.

State-run funds in Republican-led Texas, Louisiana and Wyoming also are users of Bowyer Research. The $57 billion Texas Permanent School Fund was the first state fund to sign up. …

Thousands of fund managers cast billions of votes on behalf of millions of investors on issues ranging from what executives get paid to resolutions that seek additional environmental and societal-related disclosures.

Conservative-leaning groups like the Bowyer’s want to match the sway that progressives have historically had. Currently, resolutions opposing diversity, equity and inclusion programs struggle to attract more than 2% support from shareholders.

Also:

Bowyer said he started out life as a socialist, influenced by his grandfather, a machinist who owned a bar in Easton, Pennsylvania, and had a library of socialist tomes. After reading the communist manifesto in high school and finding it too depressing, he switched to Catholic writers such as Thomas Aquinas and faith had an increasing influence over his rightward shift.

It is possible that this stuff has an economic impact, but it is pretty attenuated. These are largely votes on nonbinding shareholder resolutions about things that don’t “relate to the company’s ordinary business operations,” and Bowyer’s “goal is that if enough red-state and conservative funds adopt the guidelines, shareholder support for conservative-backed resolutions such as those opposing debanking or religious discrimination can reach at least 5%.” Getting 6% of shareholders to endorse a nonbinding resolution to change something not related to a company’s ordinary business operations seems pretty unlikely to move the stock price, but they might enjoy doing it anyway, and not everything is about the stock price.

The banks that underwrote Elon Musk’s 2022 buyout of Twitter Inc. (later renamed X, and then merged into XAI Holdings) did great. They loaned Musk about $13 billion, they held the debt for a couple of years, they got regular interest payments at pretty high rates, and the Wall Street Journal reports that on Monday “banks sold the final slug of the debt … at 98 cents on the dollar.” With interest and fees, and after selling “billions of debt at only slight discounts,” the banks almost certainly came out ahead.

Or that is the analysis if you consider (1) when the banks committed to make the loans in April 2022 and (2) when they finished selling it this week. The three years in between, though, were rough. The banks did not intend to hold the debt that long; when the merger closed in 2022, though, there were no buyers for it. At various points it seemed like the debt was worth about 50 cents on the dollar and the banks would take huge losses. Big investment banks are in a pretty mark-to-market business, and they did not enjoy this limbo. The Journal notes:

The legacy of the hung debt might have longer-term implications. X and other so-called hung loans prompted pay cuts and an exodus of bankers from Barclays, The Wall Street Journal reported. They also forced some banks to pull back on lending, which gave room for competitors in the booming private-credit space to muscle in. 

I suppose one story you could tell is that Elon Musk created private credit, or at least, that the modern boom in private credit was driven in part by banks cutting back on lending due to the Twitter hung deal.

And one reason that this gave room to private credit is that private credit is a less mark-to-market business. When banks finance leverage buyouts, they are in the moving business, not the storage business; they commit to lend and then go out to find buyers for the debt. When they can’t find buyers, they are stuck. Private credit firms are the reverse: They raise funds to buy debt, and then go out and make loans. This makes them more countercyclical: When the market drops, banks are stuck with loans commitments and can’t make any more, but private credit firms still have the funds they raised in good times and can go out and make more loans. If Musk had borrowed $13 billion from private credit funds to buy Twitter, those funds wouldn’t have fired anyone; they would have held the loans to maturity and made money. Sometimes it is helpful not to have to worry about day-to-day changes in asset values.

Secret Deals, Foreign Investments, Presidential Policy Changes: The Rise of Trump’s Crypto Firm. Amazon Denies Tariff Label Plans After White House Criticism. GM Suspends Guidance, Freezes Share Buyback on Trump Tariffs. Altman and Nadella, Who Ignited the Modern AI Boom Together, Are Drifting Apart. EU Urged to Scrap Rules That Force Short-Sellers Out of Shadows. Private credit firms take aim at ESG for holding back financing for European defence. BlackRock shareholders urged to vote against Larry Fink’s pay by proxy adviser ISS. Malta’s ‘golden passport’ scheme breaks law, EU’s top court rules. Blackstone-Backed Rover Buys Gudog in European Pet-Care Push. Ex-Credit Suisse CEO Thiam Fights Ivory Coast Vote Ban in Court. A man airlifted from Japan’s Mount Fuji returns to the slope days later and is rescued again. Margin Call is good.

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