Everyone now believes that private markets are better than public ones

But when an idea is universally held it often pays to be cautious

There was time when a sure way to establish a reputation as a campus sage was to bang on about the “dialectic”, or the action of opposing historical forces. Sooner or later somebody will apply the term to asset management. The industry is not short of would-be sages. And it has historical forces of its own to contend with. Over the past decade there has been a dramatic shift towards “passive” funds. They track publicly listed stocks or bonds that are liquid—that is, easy to buy or sell. The most popular funds are huge, run by computers, widely held and have low fees.

This passive boom has spawned its antithesis—niche, run by humans, secretive, thinly traded and high-fee. Institutional investors are rushing headlong into private markets, especially into venture capital, private equity and private debt. The signs are everywhere. A large and growing share of assets allocated by big pension funds, endowments and sovereign-wealth funds is going into private markets—for a panel of ten of the world’s largest funds examined by The Economist, the median share has reached 23% (see chart 1).

Worldwide, pools of private capital, including private equity and private debt, as well as unlisted real-estate and hedge-fund assets, grew by 44% in the five years to the end of 2019, according to JPMorgan Chase. A different way to capture the scale of the private party is to look at the quartet of Wall Street firms that specialise in managing private investments for clients—Apollo, Blackstone, Carlyle and kkr. Their total managed assets have risen by 76% in the past five years, to $1.3trn. They have long specialised in buy-outs and property. More recently they have grown in private-debt markets, too—in total their funds’ credit holdings have hit $470bn.

Venture capital (vc), another part of the private universe, is feverish. SoftBank’s Vision Fund, a $100bn private-capital vehicle backed by Saudi Arabia’s sovereign-wealth fund, has funnelled cash into fashionable, unlisted startups. Other institutions have vied with it to write big cheques for Silicon Valley’s brightest new stars. Already some of these bets have gone awry. WeWork, an office-sharing deity-turned-dud, had to cancel an initial public offering (ipo) in 2019 after public-market investors balked at its valuation. This week Casper, a loss-making firm that sells mattresses on the web, announced that the value it is seeking at ipo is below its $1.1bn valuation at its previous funding round.

The flood of capital into private markets ultimately rests on the belief that they will outperform public ones. There is evidence for this—in the past the best-run private-capital managers have beaten the returns from public markets, even after generous fees. And there are grounds to believe that this was no statistical fluke. Private capital, say its boosters, reduces “agency costs”. These arise wherever somebody (the principal) delegates a task to somebody else (the agent) and their interests conflict. Consider the public markets—no one has a big enough stake to make it worthwhile to monitor firms, which as a result get complacent or indulge in short-term earnings management to the detriment of the long term. Private capital, which is closely held in a few hands, is supposed to get around such agency problems.

Yet every investment craze is liable to overreach, blindness to risk and misallocated capital. Recent converts to the private world, dazzled by the historical returns, may not fully appreciate the hazards. The capital washing into San Francisco’s venture-capital industry has bloated both the value of pre-ipo companies and the egos of founder-managers. The big concern is that a shift from public to private capital merely swaps one set of agency conflicts (shareholders v company managers) for another (shareholders v private-asset managers).