Partners Group, the global private markets investment manager, concludes in a White Paper published today that the outperformance of private equity over public equity, which is often linked to a combination of capital structure, illiquidity and operational effectiveness, is ultimately attributable to superior corporate governance.
The White Paper, The rise of 'Governance Correctness': How public markets have lost entrepreneurial ground to private equity, argues that public companies are constrained by an excessive focus on corporate governance practices that, in many jurisdictions, have evolved so far beyond their original mandate to protect shareholders that instead they have become obstructive to long-term value creation for all stakeholders.
Describing in largely qualitative terms the increasing divergence between the governance regimes of public versus private companies, the Paper shows how public companies face pressure from external forces such as specific regulations, proxy advisors, governance and so-called best practice codes as well as investor short-termism, while private companies are generally subject to a more flexible and entrepreneurial style of governance. In doing so, it draws on Partners Group's special perspective as both a private markets investment manager and successful listed company - since its IPO on the SIX Swiss Exchange in 2006, Partners Group's market cap has grown to about CHF 20 billion, making it one of the largest private markets investment managers by market cap globally.
Steffen Meister, Executive Chairman of Partners Group's Board of Directors and Co-author of the Paper, states: "A worrying trend has emerged in parts of the public markets, where the requirement to adhere to corporate governance codes and industry 'best practice' seems to be overshadowing the need to direct and enforce a value-enhancing strategy at many corporations. In this Paper, we have christened this phenomenon 'governance correctness'."
He continues: "At the same time, the private equity industry has evolved significantly, moving away from financial engineering and toward value creation as the primary driver of growth at portfolio companies - and ultimately therefore of returns to its investors. In doing so, it has been supported by a corporate governance regime that enables entrepreneurialism in its purest form."
Looking to the future, the Paper asserts that the era of private markets investors being able to buy private assets more cheaply than those in public markets has come to an end and that the current parallels in valuation levels are indicative of a structural - not cyclical - shift in market dynamics. In this context, Partners Group believes the ability of private markets managers to actively create value, enabled by a governance framework that supports entrepreneurialism, will become the primary driver of the industry's returns.
Adds David Layton, Partner, Head Private Equity, Partners Group: "We believe that 'governance correctness' has become so entrenched through regulations and codes that it is likely to persist for the foreseeable future in public markets; in contrast, private equity firms will continue to emphasize entrepreneurial governance models as they refine and specialize their value creation skillset. Private equity will therefore continue to outperform public equity, even as the industry becomes more competitive and valuations remain more directly comparable to those in public markets."
Noting that onerous corporate governance regimes may be one reason for the decline in the number of public companies in the US and UK in the past two decades, the White Paper concludes by predicting that longer-term private equity strategies will become a more common feature of the market, driven by demand from both long-term investors and management teams of private companies.
To download a copy of the White Paper, please visit: www.partnersgroup.com/research