Private vs. Public Markets: The Illiquidity Premium

Introduction: The Pension Fund Propellant
The Appeal of Private Equity’s Purported Promise
The Complications of Competition
The Concern with IPOs: A Seller’s Market
Dry Powder Targets: Potential Winners
Conclusion & Exhibits

Introduction: The Pension Fund Propellant

With 2018 IPO activity reaching its highest level since 2014 some industry commentators have speculated that 2019 could be an even bigger year due to a stampede of Unicorns. Research from both academics and the NBER have estimated that many of these unicorns could be overvalued by as much as 50%.^{1,2,3,4,5,6,7} Kailash has read reports by McKinsey & Company⁸ and Bain & Company.⁹ Both publications were largely intellectually congruent concluding that private equity has performed well, continues to raise large amounts of capital and has become a consensus “buy.” McKinsey also notes that US Pensions are the largest existing LPs.¹⁰

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The McKinsey report led out with a staggering chart (Fig. 1 below) showing the average funding gap of US public pensions had exploded from $1.8 trillion in 2007 to roughly $3.8 trillion since the Great Financial Crisis. Despite the near 13% annual returns of public equity markets, to which public pensions are heavily exposed, a confluence of events have caused that funding gap to persist. Aside from falling expected rates of return and revised mortality rates, the report implies that a primary cause was that while “…most pensions have sizeable exposure to equities, many recognized significant losses at the time of the downturn and did not reallocate with sufficient alacrity to take full advantage of the past decade’s bull run¹¹.”

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