It's open season on private equity in the Democratic presidential debates. Sens. Elizabeth Warren and Bernie Sanders and others have made attacking Wall Street a major plank in their campaign platforms. There's nothing new about inventing a common enemy to ignite a movement. But what is different this time is the level of demonization and the proscribed penalties on offer.
Reasonable people can disagree on the tax treatment of carried interest, but much of the campaign bluster and its underlying insistence on the evil of private capital represent a fundamental misunderstanding of how markets work, and its implementation would do huge damage to the efficient allocation of capital within the U.S. economy and beyond.
Needless to say, perhaps the greatest of ironies is that many of the underlying investors/beneficiaries in private market allocations are the very teachers, police officers, firefighters and hard-working public employees that this fearmongering claims to protect. But I digress.
In making the case against private funds, the primary dialogue has leaned heavily on anecdote, emphasizing worst-case scenarios. There's no disputing that these examples have "posterized" the worst of excess, but they don't represent the majority of general partners, funds, asset managers, or the generally positive impact that private capital has had on business formation and economic growth. Regardless of your politics, the plural of anecdote is still not data.
Our organization, the Chartered Alternative Investment Analyst Association, represents savers, beneficiaries and the general public. As such, we proudly occupy objective middle ground — we're not trying to win a campaign with dramatic sound bites nor blindly protect a revenue stream or business model for the investment profession at the expense of Main Street. The ultimate goal of the financial markets after all is to efficiently allocate investment capital to the most socially and economically sound opportunities — giving asset owners access to a variety of diversified cash-flow opportunities to help them meet investor outcomes. And diversification across the full risk premium spectrum, including private asset classes, is a founding principle of proper fiduciary responsibility.
As such, a more balanced platform is needed and that starts with recognizing the unique benefits of private capital. Most importantly, private investment is generally unmoored from the short-term machinations of public markets, allowing managers to avoid the herd mentality and the distracting gyrations of the media news flow. This provides much better alignment of investors and management for long-term value creation as it liberates investors to take advantage of market dislocations, information asymmetry, and out of favor or countercyclical opportunities. And, it facilitates a more natural channeling of long-term pools of capital into impact and environmental, social and governance projects such as infrastructure, real estate, clean energy, agriculture and water.
From a business perspective, private funds tend to overwhelmingly focus on startups and small- and medium-size businesses, generally seen as the economy's engines of creativity, job creation and middle-class wealth. These companies are often research and development intense, with little in the way of tangible assets, and in significant need for growth capital. They are the mirror image of the traditional, asset-heavy organizations listed on public markets. The ability for private markets to more quickly and effectively revitalize stagnant businesses or simply redeploy that capital to entrepreneurs' innovative ideas is a disruptive force that is a critical principle of any competitive and growing economy.
For all these reasons, particularly their alternative and uncorrelated cash flows, private capital asset classes should be a considered a core piece of any long-term diversified portfolio. As such, experts anticipate continued increases in allocations to private and alternative assets. Willis Towers Watson, for example, expects allocations from institutional investors to continue to increase to 20% within 10 years from about 14% today.