This year’s flood of new topics brings with it a message: In addition to opportunities, there are hidden risks. In contrast to bailing out companies facing lockdown challenges in 2020, the new trend is mainly through private equity-backed initial public offerings (IPOs).
High valuations remind us of the value in private markets – great wealth that can be created long before other stock market investors gain access. Private equity returns have historically outperformed publicly traded stocks, but the Woodford saga made it clear how much expertise is required to invest in this asset class. However, could these new problems have particular challenges even after they are listed?
Moving to the public arena doesn’t remove all risks, but new owners may be less able to manage them.
Behavioral finance recognizes the importance of incentives and how conflict can mislead behavior, but typically the new investors have little control over it when they go public.
In fact, many of the new issues are not bringing in their non-executive directors until shortly before they go public. How much governance can really be put into the restructuring to meet listing requirements?
Independent non-execs often have little influence at this stage, while founders and private equity owners set the terms. Of course there is IPO research and investor training, but the investment banks and analysts involved in an issue are usually the main source of information.
Mifid regulation appears to have exacerbated this information imbalance. Active buyers will be expected to do work that will aid pricing but may receive little or no stock allotments upon launch.
The assessment of the ESG is also a public good that is largely borne by active managers. Those involved in the issue are rewarded and passive investors can participate and rely on others’ pricing. For active managers, however, this can be a poor risk / reward calculation, even if the “pop” in question is large.
Many investment institutions can often get a zero allocation in hot issues. The government sees London listing as a post-Brexit commercial opportunity, but it’s about maintaining a healthy functioning ecosystem, not just dropping standards.
Blur public and private
Woodford has not prevented private equity interests from being added to retail investor portfolios. Many funds have sprung up to gain access to this area and the FTSE 100 itself has seen new entrants from the world of alternatives and private markets.
Indeed, low-cost passive index exposure vehicles can now actually embed high-cost actively managed funds. However, regulation is firmly focused on the publicly traded world. Corporations, institutional investors and investment banks. Little of this oversight goes into private equity.
Despite the regulation, the boundaries between public and private are becoming more complex and risky for private investors. The line of regulation has encouraged crossover investors to help companies transition into public trading.
Typically, these parts are part of the cornerstone of a new problem that is often preferred during initial assignment.
Now there also appears to be official encouragement for vehicles giving retail investors access to new topics, but with much more restricted rights to pre-float information.
Broader equity ownership might be a good thing, but the UK privatization experience reminds us that IPOs are often not a good start to this investor journey.
In addition to ongoing changes, special purpose vehicles are helping to buy late-stage and pre-IPO private equity rounds are helping give more institutional investors access to pre-float prices.
Special Purpose Acquisition Companies (Spacs) also play a role. These are effectively clams that compete with investment banks to provide value for founders and private equity owners.
The pace of change and increasing complexity certainly requires more scrutiny than assuming that the UK could be an easy home for all of this.
Investors buying private equity IPOs need to recognize how different the two worlds are. Private companies are set for float, but investors need to look beyond appearances.
Governance is often in the works for years after the IPO. This is the challenge for the new stock market investor, along with the consequences of conflict, aggressive incentives and innovative metrics. New editions come with excitement and fantastic numbers; But understanding behavior can be more important.
Citywire A-rated Colin McLean is the founder and director of SVM Asset Management. The SVM UK growth Fund that he runs alongside A-Rated Margaret Lawson, returned 13.7% over three years versus a peer average of 7.6%.
Colin McLean: Be careful if you see a dash for IPOs