The decline in working capital is drying up the IPO market

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Roula Khalaf, Editor of the FT, selects her favorite stories in this weekly newspaper.

The author is a senior consultant at Engine AI and Investa, and a former senior global equity strategist at Citigroup.

“The job of an investment banker is to stay where the money is.” That was the direction of a former colleague many years ago. Maybe it’s obvious and common sense but the best advice is often.

I can tell you where the money isn’t – UK active equity funds. According to Goldman Sachs, around £150bn has flown out of them since 2016.

There are many reasons for this trend. In equities, disappointing performance from the UK stock market forced investors to chase positive returns elsewhere. Poor performance and high interest rates made money cheap. Local history discrimination created a desire to diversify into other equity markets.

As defined benefit pension funds grew and used Liability Driven Investment strategies that sought to match income with pension benefits, they sold UK equities and bought gilts. These steps were accelerated by regulatory and accounting changes. Gordon Brown’s 1997 removal of tax credit did not help. However Brexit did not.

Pension funds and endowments, attracted by the strong returns of the “Yale model” portfolios, have moved large sums of money out of public markets and into other assets such as real estate, real estate, mutual funds hedge and private equity.

Many of these titles also play in the US. Morningstar data suggests that the rise in passive investments means that only 37 percent of US equity fund assets are now actively managed, up from 60 percent in 2015.

My main point is that the biggest losers in recent years have been active equity managers, even in the US. These natural buyers of IPOs are hungry for capital. Passive equity funds enjoy income but rarely participate in new issues. They can buy as soon as the stock is included in the index they track, which usually takes time. It appears that IPOs have become an unexpected risk factor in the rise of passive investing.

A new supply chain market requires capital inflows into equity funds. The UK has seen permanent exits. The US has seen an increase in equity income, but in non-working capital. The capital has helped rebalance the biggest tech stocks in the S&P 500, but it hasn’t found its way to fund managers who can buy the next new issue. Hence the dramatic manipulation of US key indices, which are reaching new highs, and IPOs, which are still there.

India is another country where the rising premium market is associated with an uncertain new supply. But here, most of the flow has been in working capital.

There has been much speculation about the end of equality provision in the UK. The government has been encouraged to adopt policies that will bring local savings back into the local stock market. If most of this money is in passive funds, as seems likely, there will probably be new values ​​for major UK stocks. This may discourage them from transferring their listing to the US, but it is unlikely to revive the local IPO market. To do so, policymakers need to divert money from potential fund managers to new issues.

Private equity funds have attracted some of the funding from active public funds. This supported their war budgets while depressing the stock market, thus offering cheap deals. However, this can only go so far. The PE business model also requires a healthy IPO market to return capital to liquidate investors. With active social equity managers that decline, that exit path is narrowed.

Perhaps the answer is for companies to remain secretive. Avoid the hassle of a public listing and the short-term pressures of a volatile share price. In addition, there is a lot of money available in the private markets. David Solomon, the chief executive of Goldman Sachs, gave exactly that advice recently, and he certainly knows where the money is.

“If you’re running a company that’s working and it’s growing, if you go public, it’s going to force you to change the way you run it and you really have to do that very carefully,” he said. saidindicating that now you can earn money secretly in bulk.

Continued outflows have important implications for public equity markets. There has been little shortage of new shares, and many old shares have been abandoned, thus reducing the available investment pool. For many, this decline indicates a sick market. I see it as a necessary reduction in the supply of public equity due to the drop in demand, especially in working capital. Ultimately, this should support share prices.

I spent the first part of my career as a UK policy expert. My main clients were working UK fund managers. As their flow increased, I realized that I needed to spend some time, so I switched to a global order. A job-enhancing process, but I would have moved to the private markets. That’s where the real money is.