The global ETF industry has enjoyed rapid growth, now controlling a massive $5.8 trillion in assets under management (AUM). However, private capital funds are pulling in new money from investors at about double the rate of ETFs, per a report in the Financial Times. Private equity, venture capital, infrastructure, real estate, and private debt funds are among those participating in this growth spurt.

In 2018, the net new money flowing into ETFs was up by 9% from the prior year, but slowed to a growth rate of 8.2% in the first half of 2019, per data from Morgan Stanley cited by the FT. Meanwhile, the growth rate for private capital funds increased from 14% in 2018 to 15.1% in the first half of 2019.

Key Takeaways

  • Private capital funds are pulling in new money at an accelerating pace.
  • They are collecting new money at almost double the rate for ETFs.
  • An attraction is potentially higher returns than public stocks.
  • Some investors also see private capital as less volatile.

Significance For Investors

Morgan Stanley observes what they call a "barbelling" of the investment management industry. The largest net inflows of money are going into opposite ends of the investment management spectrum, low-cost passive investment vehicles that track indexes, such as most ETFs, and high-cost actively-managed funds that offer the potential for significant outperformance, such as private capital. Meanwhile, the mainstream investment funds caught in the middle saw their net new money grow by a paltry 2.3% in the first half of 2019.

While the pursuit of higher returns typically entails assuming greater risk, many investors in private capital believe the opposite. Since the assets that these funds hold are not traded on public markets, they often are seen as less volatile, the FT notes.

Earlier in 2019, asset management giant BlackRock Inc. (BLK) surveyed 230 institutional investors with collective AUM exceeding $7 trillion. Among them, 51% planned to reduce their holdings of publicly-traded stocks, but nearly as many intended to increase their exposures to private capital. BlackRock and Franklin Resources Inc. (BEN) are among the leading asset management firms that are expanding their footprint in private capital, partly through acquisitions.

The rapid growth of private equity represents “one of the most profound shifts in the capital markets since the 19th century,” according to a new report from international public accounting and consulting firm Ernst & Young, as quoted by Institutional Investor. “If you’re not invested in private equity, or private capital, then you’re really missing out on where our economy is growing," as Peter Witte, associate director of the private equity group at E&Y, told Institutional Investor.

Private equity funds alone now have global AUM of about $3.4 trillion, up sharply from about $500 billion in 2000, per E&Y. They estimate that the entire private capital universe, also including categories such as infrastructure, real estate, private debt, and natural resources, is a massive $6 trillion worldwide. Additionally, they find that roughly 66% of institutional investors have money in private equity, with an average portfolio allocation of 10%.

Meanwhile, per data from the World Bank cited by E&Y, the number of publicly-traded stocks in the U.S. has been cut nearly in half during the last 20 years. Moreover, companies backed by private equity firms now employ almost 9 million people in the U.S. alone.

Looking Ahead

“As more capital flows into private equity, or private capital, there’s naturally going to be a more important role for regulators to play," Witte observed. Indeed, Senator Elizabeth Warren, a presidential candidate, has made private equity a political target with her proposed "Stop Wall Street Looting Act."

Meanwhile, E&Y estimates that if wealthy individuals who qualify as accredited investors shift just 1% of their current holdings of public equities to private equity, that would represent $149 billion of net new money. A similarly modest shift by institutional investors also would create significant inflows to private equity.

Regarding ETFs, a new SEC rule that streamlines the approval of custom creation and redemption baskets has been hailed as a big positive for that industry. Such baskets can reduce tax liabilities for investors and improve investment returns.