The Trouble With Public Access to Private Markets
Small investors are unlikely to know what they’re doing—and the effect on public markets would be undesirable.
By Hunter Lewis
Getty Images/iStockphotoWhile the public stock market shrinks, the private market expands.
Now small investors may finally be invited into private deals, but probably only second-rate ones for confiscatory fees.
Is this what we want?
I bear some responsibility for what is happening.
Total venture capital in the U.S. amounted to only $400 million a year when I began my career.
But I recommended a venture-capital fund to the Yale University investment committee in 1976 and began finding “alternative” investments for my clients.
I worked closely with David Swensen, who arrived at Yale in 1985 and perfected the so-called Yale Model, which accelerated institutional investing toward illiquid alternatives with a long time horizon.
Not everyone praised this approach.
Warren Buffett’s partner, Charlie Munger, in a 1998 speech criticized the layering of fees.
These included 2% annual plus 20% of profits or even higher fund fees, and a proliferation of fund-of-fund, consulting and outsourced chief investment officer fees.
The math supported Munger’s reservations.
Fast forward to 2022, when the venture-capital industry hit a road bump, as I predicted it would in these pages.
Now the industry limps along by focusing on artificial intelligence; private equity also has experienced setbacks and looks even wobblier to me.
In this challenging environment, “alternative” managers have begun looking at small investors as a potential solution.
Their money is seen as fuel for growth and, perhaps more important, as exit money to satisfy the clamor of current investors who want out.
President Trump (in an August executive order) and the Securities and Exchange Commission have endorsed opening private markets to small investors.
But there are pitfalls beyond the obvious problem that small investors may not know what they are doing.
One is the effect on public markets.
The number of U.S. public companies exceeded 7,000 in 1997.
Today’s total is less than half that and falling.
Hamilton Lane reported in 2022 that only 13% of U.S. firms with more than $100 million in sales were public, leaving 18,000 companies out of reach to small investors.
Letting small investors into private funds would address this situation, but it could turn out badly for investors and the market.
Most small and intermediate-size companies can be accessed only through exorbitant fees such as the “2 and 20” for venture funds and the multilayer fees for funds of funds.
And what will be in it for investors?
Will Wall Street share the best private deals with the public or keep them for itself and favored customers?
To broaden access to private markets, we should first restore public markets for small and medium-size companies so that all investors have an array of public and private choices.
To do this, we must remove the disincentives that keep smaller companies from going public:
• Congress has interfered with public-company CEO compensation, which has led to a reliance on options and fostered semi-privatization through massive stock repurchases.
• Public-company CEOs have been burdened with unreasonable legal liabilities such as personal responsibility for the accuracy of even the minutest details in all financial statements.
• The costs of issuing public stock and regulatory compliance have become too high for any but giant companies to bear.
• Quarterly reporting and Wall Street demands for immediate “good numbers” have encouraged a short-term perspective, which may foreclose important long-term investments and thinking.
• Because so much stock investing has morphed into index investing, new public companies, which are unlikely to join an index, become orphaned.
Having more public companies won’t help this situation, which requires new thinking to solve.
If I were at the SEC, I would be asking: Is it a good idea for small investors to be concentrated in a limited number of giant companies through index funds that are weighted by capitalization and that buy regardless of price?
Will exchange-traded funds hold up during the next extended bear market?
Their liquidity hasn’t been tested.
Are investor funds safe with the few brokerages that dominate the small-investor market?
Will Securities Investor Protection Corp. insurance provide enough protection?
The small investor is perennially at risk.
As Malcolm Bryan, president of the Atlanta Fed in the late 1950s, said: “We should have the decency to say to the money saver, ‘Hold still, Little Fish!
All we intend to do is to gut you.’ ”
Mr. Lewis is a co-founder and former CEO of Cambridge Associates and founder of Hunter Lewis LLC.
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