Wed Feb 26

Your super fund is invested in private markets. What are they and why has ASIC raised concerns?

Written by Mark Melatos, Associate Professor of Economics, University of Sydney

If you are a member of a super fund, some of your long-term savings are probably invested in private markets.

Public markets are familiar to most of us – the stock market and government and corporate bond markets. Private markets include unlisted assets such as companies owned by private equity firms, infrastructure investments and private credit markets.

Corporate watchdog the Australian Securities and Investments Commission (ASIC), has today released a discussion paper ^[1] that emphasises the growth in private capital, seemingly at the expense of public markets. While the number of listed companies and the value of initial public offerings ^[2] has shrunk, private equity and infrastructure funds have boomed.

Should we be worried about this?

Public vs private markets

Public markets tend to be transparent, tightly regulated and liquid. Companies listed on the stock exchange publish their financial accounts, hold annual general meetings and their shares can be readily traded.

In contrast, private markets are lightly regulated. Private capital investments are more opaque, less liquid and, hence, more risky. But they can deliver much higher returns (or losses).

Often, obtaining capital from private sources makes sense. For example, entrepreneurs whose startup firms are short of revenue, profit and tangible assets are unlikely to be able to raise capital in public markets, or from banks. Instead, they turn to private equity firms for funding.

What are the concerns?

In its report, ASIC raises several concerns:

the shrinking of Australia’s public equity markets might hurt the economy
the rise of private markets may create new or amplified risks
the lack of transparency of private markets poses a challenge for investors and regulators.

Public markets play an important role connecting investors with companies seeking capital ^[3]. The shrinking of public markets, therefore, has important economic implications. Will private markets be able to pick up the slack?

Notwithstanding the growth in private capital markets, they are still small compared to their public counterparts. The total capitalisation of the Australian Stock Exchange (ASX) is $3 trillion. Total private capital funds under management are only $150 billion.

Listings of new companies on the ASX have declined over the past decade. Luis Enrique Ascui/AAP

The lack of disclosures in private capital markets might also create more and different risks for financial markets and the economy; risks that regulators may not understand, nor know how to anticipate or effectively mitigate.

The role of Australian super funds

ASIC is concerned about the implications for the superannuation industry of the growth of private capital markets and decline in public markets.

Australia’s superannuation assets now total $4.1 trillion,^[4] greater than the value of Australia’s GDP and more than the total value of all companies listed on the ASX. Anything that alters the playing field for Australian super has the potential to create outsized risk (or opportunity) for the Australian economy.

The ASIC report highlights the growing involvement of Australia’s superannuation funds in private markets. Australia’s two largest super funds, Australian Super ^[5] and Australian Retirement Trust ^[6], each have about 20% of their total funds invested in private markets.

The fact is that Australia’s superannuation sector has outgrown Australian public markets. They cannot trade shares on the ASX without moving share prices significantly to their detriment. On the other hand, having super funds, which are highly regulated to protect member savings, investing in unregulated private capital markets is jarring, if not potentially risky.

Having said this, the size of Australia’s super funds means they can set the terms and price at which they invest. This power is most valuable in private deals; less so in public markets where a company’s stock price and its financial accounts are public knowledge.

Increasingly, super funds directly invest in infrastructure projects such as ports and airports rather than buy shares in listed infrastructure firms.

What’s behind the shift in markets?

The ASIC report points the finger at the usual culprits for the shift from public to private capital markets, including the regulatory burden on public companies and the rise of technology companies that prefer to tap private capital.

ASIC chairman Joe Longo has raised several concerns about the dynamics of public and private markets. Joel Carrett/AAP

However, another problem is bedevilling policymakers everywhere: too much capital is chasing too few profitable investment opportunities. Companies have lots of cash on their books and nothing to spend it on.

Increasingly, such companies have resorted to share buybacks (reducing the number of their shares on issue) to reward investors in a tax-effective way. A lot of the shrinkage in public equity is due to share buybacks that in 2022 alone totalled US$1.3 trillion ^[7].

Why does all this matter?

The ASIC report is notable for what it does not say; nothing, for example, on its own chequered history of investigative and enforcement action ^[8].

The growing importance of opaque private markets matters more if regulators are asleep at the wheel. ASIC’s tendency for weak oversight and sclerotic enforcement can hardly have raised investor confidence in Australia’s public capital markets.

Its oversight of initial public offerings (IPOs) has also been questionable over a long period. How can ASIC be expected to adequately manage complex private capital market risks given its woeful performance managing simpler public market risks?

The apparent decline of public markets has been spooking even sophisticated private financial market players – including, most notably, Jamie Dimon, CEO of JP Morgan ^[9]. If Dimon is concerned, then ASIC – and all of us – should probably also be concerned.