Simon Dawson/REUTERS; Samantha Lee/Business Insider
- With 2020 quickly approaching, Business Insider is polling experts to find out what finance and real estate will likely look like a decade from now.
- The public markets are no longer the kingmakers they were for legendary stock-pickers like Julian Robertson and Peter Lynch. The savviest discretionary managers are diving into the private markets to boost their returns.
- Over the next 10 years, insiders, consultancies, and banks all expect this migration to less efficient private markets to accelerate.
- With fewer public companies and an IPO slowdown, the private market opportunities for hedge funds like Tiger Global and Coatue have become more attractive, even as sky-high valuations have plagued investors that dove into companies like WeWork.
- Investors, according to a recently released note from Carlyle, are leaving their public markets exposure to quant funds and passive indices, and searching for alpha in the less efficient private markets.
- "The lines are blurring between hedge funds and private equity, and I expect the industries over time to converge," said Don Steinbrugge, founder of consultancy AgeCroft Partners.
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The smart money is getting out of the public markets.
Private equity, once an obscure part of the alternatives space, will have more assets than the better-known hedge fund industry by 2023, according to Preqin. Institutional investors, meanwhile, are shifting more of their portfolios to the private markets, according to EY, in part due to underperformance of active managers in the public markets.
With 2020 quickly approaching, Business Insider is looking ahead and polling experts to learn what Wall Street will look like in 2030. Over the next 10 years, insiders, consultancies, and banks all expect this migration to less efficient private markets will continue and accelerate.
Passive investing, which topped half of all mutual funds assets for the first time in 2019, will only continue to rise, they say, and finding an edge in the public markets will become nearly impossible thanks to advances in computing power and data-processing.
We've already seen the effects of this sea change on value investors, who have struggled to make money using a strategy pioneered by legends like Benjamin Graham and Warren Buffett. In 10 years' time, nearly all big discretionary managers could see a public market void of obvious plays.
Managers are already diving into the private markets
Already top stock-picking hedge funds - managers who made their names and their billions with concentrated bets on well-known, public companies - are seeing the light.
Viking is growing its private markets team after putting more than a half of a billion dollars to work in the private companies during the first half of this year, while Tiger Global and Coatue have become some of the biggest early-stage investors. Point72 and Two Sigma have built out venture capital arms, and Lone Pine is opening up another of its funds to private investments.
One of the top-performing hedge funds this year, Mudrick Capital, can thank its large stake in Juul for its success, though that may be in peril thanks to the rash of vaping-related deaths in the United States. Billionaire Joseph Edelman's Perceptive Advisors closed its first venture capital fund with $210 million from institutional investors and family offices, the firm announced in December.
"The demand for less liquid securities will grow over time as more and more view it as an area that investment firms have an edge and where high returns can be generated relative to liquid markets," said Don Steinbrugge, founder of consultancy AgeCroft Partners.
"The lines are blurring between hedge funds and private equity, and I expect the industries over time to converge."
Mutual funds are even getting in on the private market action, though with a close eye from the Securities and Exchange Commission. Fidelity is in Juul, WeWork, and Airbnb, and T. Rowe Price and Franklin Templeton have invested in unicorns as well.
Active managers have turned to the private space for several reasons - like exploding valuations and the shrinking roster of public companies - but the biggest is that it's just hard to make money in an arena that's becoming more efficient everyday.
'It's much harder to beat a computer'
Passively managed mutual fund assets have shot past their actively managed peers; an IMF report states that the total assets tracking an index reached $4.25 trillion this year.
Beating the market is a zero-sum game for active investors, said Jamie Dinan, founder and chief executive of York Capital Management, at the Project Punch Card conference in December. The rise of passive, he said, has upped the competition because it took away clueless investors that didn't know what they were doing.
"It's much harder to beat a computer or a really intelligent person," he said.
And quants are finding new areas to exploit much quicker now thanks to increased computing power, advancements in artificial intelligence and machine learning, and an explosion of new, alternative data streams that have quickly become a necessary cost for managers hoping to keep their heads above water.
Investors in hedge funds are concerned that they're paying large fees to get the same type of returns that retail investors can get for free - and that hedge funds in the public space are simply following each other.
Crowding has gotten worse the last three quarters, according to Goldman Sachs' hedge fund tracker. Amazon, Facebook, and Alphabet make up 5% of all hedge funds' long portfolios, Goldman says, and those three stocks have been among the top five positions in hedge funds for the last 14 quarters.
And public market options are shrinking by the day, with mergers and buyouts - like Elliott and Francisco Partners recent discussions to take LogMeIn private for $4 billion - outpacing IPOs.
The private markets are flooded with money, while the biggest unicorns have struggled out of the gate once public, or didn't even make it to the IPO, like WeWork. Now companies like Palantir are pushing back their public offerings.
For underfunded pensions, the private markets are the only place to make eye-popping returns once common of hedge funds.
A Natixis survey of 500 institutional investors managing more than $15 trillion found that 37% are increasing their allocation to private debt next year while 28% are bumping up their allocation to private equity. The top talent is going with the dollars too, as hedge funds are finding tough competition to reel in for the smartest investors from the private side.
'We aren't going back'
Dev Kantesaria, CEO and founder of stock-picking hedge fund Valley Forge Asset Management, believes the story of the next ten years will be the impact of "relentless market share gain by passive strategies."
The bloated hedge fund industry - which has thousands of funds chasing similar trades - is expected to shrink, and Kantesaria expects those assets from closed hedge funds to flow into passive products.
"Once you're indexing, you don't get those investors back very easily," he said knowingly: Kantesaria serves on the board of a hospital that recently put a good chunk of its endowment into a Vanguard index fund, and "we aren't going back."
The size of individual hedge funds that are used to beating the overall market may be holding them back, says Chris Walvoord, global head of hedge fund research and portfolio management at Aon.
"A lot of traditional hedge fund firms are becoming more institutionalized. They can't do the things they used to," he said.
"Investors are still in the process of getting heads around what hedge funds are able to do at certain sizes."
Walvoord is not completely dismissing active managers trying to outperform in equities - "there will still be opportunities for people to look in the nooks and crannies" - but in 2030, it will be tougher.
A recent note from Carlyle's global head of research Jason Thomas states unicorns' preference of private money over the public markets and the lack of young, growing public companies have created a "new paradigm for portfolio management."
"Investors rely on private markets for 'alpha,' while passive allocations deliver more efficient and targeted 'beta,'" he wrote.
This shift might force investors to rethink the term alternative investments.
"Rather than an 'alternative' asset class, private capital represents the 'active' portion of institutional portfolios, responsible for diversification, excess returns, and important signals about changes in the broader investment opportunity set," Thomas wrote.