Tuesday, April 7, 2015

Public earnings buying private firms

A few weeks ago there was a story that caught my interest, and I'm just now getting time to blog about it. The amazingly entertaining and informative Matt Levine pointed us to the NYT story:

Big money managers including Fidelity Investments, T. Rowe Price and BlackRock have all struck deals worth billions of dollars to acquire shares of these private companies that are then pooled into mutual funds that go into the 401(k)’s and individual retirement accounts of many Americans. With private tech companies growing faster than companies on the stock market, the money managers are aiming to get a piece of the action.

I think this is a cool story for two reasons. First, I've complained before about the inability of small investors to own young, non-public companies in a diversified way. Unless you're an accredited investor, you can't really get into venture capital or private equity (and even if you could, then you'd have to pay huge management fees). The only way for me to own non-public firms is to start one, and then I won't be diversified. But we know that private firms are different from public firms, so holding a diversified basket of public firms isn't really owning the whole economy (by the way, this is what annoys me about Buffett's "favorite stock market indicator"). For one thing, public firms are almost never young--that NYT comment about "private tech companies growing faster than companies on the stock market" has probably always been true and is probably true in other industries. Since young firms are the ones growing quickly, leaving them out of your portfolio seems nontrivial (with all the caveats about how the bulk of them actually have zero growth potential). Levine points out a complaint some people have about this:

One worry is of course that the big investment professionals might lose money on these investments, since the professionals are perhaps not experts at private company investment, and since the investments are made at pretty fancy valuations. My view is that you can lose money on public investments too, and there are lots of reason not to worry too much about your pension being invested in Uber.

We already know that professionals aren't great at picking public stocks--or, at least, their abilities aren't paying off for their investors. So I don't have a reason to think they're any worse at picking private ones. But I admit that this is way outside of my wheelhouse; I just think it's interesting that these vehicles for investing in private firms are being made available to regular people. That's sort of how I've always thought of Berkshire Hathaway, by the way.

The other reason I find this story interesting is that J.W. Mason has done this interesting empirical work (I discussed it here) documenting a declining propensity to reinvest earnings among public firms. Mason's empirical facts are interesting and persuasive; what I found less persuasive was the conclusion that he was drawing from them: that this trend hurts workers. I don't think we know that yet because that depends very much on where the money is actually going. I'm a macro person, and macro people are pretty obsessed with aggregation identities and general equilibrium stuff, and I don't see Mason's story happening in general equilibrium. He asked me on Twitter what he could do to make his story convincing, and I think the answer is that he could try to trace where that money is going. If it's going under rich peoples' mattresses, or if it's being set on fire or thrown in the ocean, then his story might have legs. Though I think the mattresses thing isn't out of the question, I'm still pretty skeptical of that theory. This story about earnings being invested in private firms seems like one piece to the puzzle.


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