Vanguard, the non-profit financial giant that single-handedly revolutionized the investment management world, reportedly wants to join the private equity party train. Is this another market that it intends to overhaul by passively managing and micro-pricing index fund offerings to the masses, or is Vanguard worried about missing a possibly overheated market that its clients find sexier than public equity?
Vanguard has watched as its primary market for publicly traded US companies has shrunk from a high of 7,500 at the end of 1995 to around 4,400 at year-end 2018. Although the total public market value has grown considerably through appreciation during this period, the private equity industry has raised $1.6 trillion in funds over the past ten years, with $166.4 billion alone in 2018, according to Pitchbook data.
Huge piles of cash in growth-hungry public corporations as well as private equity and sovereign wealth funds scoop up acquisitions, limiting the supply of traded equities. In addition, given the regulatory requirements for public companies and the sometimes nausea-inducing stock price response to earnings, it is no surprise that managements choose to stay private longer.
So, it makes sense that Vanguard may be on the prowl for another market, but is this the right one? Its sweet spot has been asset classes which it believes are, or should be, large and growing, efficiently priced, passively managed, widely available, highly liquid, and very low cost to investors. On the surface, PE is only large and growing, so how do they achieve efficiency, liquidity, and rock bottom pricing?
Over the past ten years, the returns on private equity have exceeded those of the S&P 500, at 14.3% versus 13.1% compounded annually (source Cambridge Assoc.) Vanguard may expect that huge capital pools chasing limited attractive deals will pressure returns. This may finally cause investors to balk at the 2% and 20% fee model, readying the market for the type of price squeeze for which Vanguard is famous.
On the one hand, Vanguard, through partners, such as HarbourVest and Pantheon, could assemble a huge private equity mega-fund containing numerous individual funds, mimicking an S&P 500-type index. Then, of course, it needs to build a PE exchange on which to facilitate trades and an acceptable and frequent pricing mechanism.
Investors should wonder whether this market lends itself to the Vanguard treatment. Among the many outstanding and thorny questions are how to value private companies that are highly opaque; how to regulate the pricing and disclosure process; and how to handle resistance from the embedded players.
On the other hand, maybe Vanguard just wants to offer its wealthy investors, who are willing to accept illiquidity and relatively high fees, the option to participate in another financial market producing high returns. Eventually, we'll find out.
If Vanguard's goal is true transformation of private equity, it will be the whale against a school of sharks.