This year’s U.S. presidential election season, like most, is dishing up more conflict than insight. One of the most distracting questions? Whether private equity is inherently good or bad.
The American public should, and will, test Mitt Romney’s claims that he can turn around the American economy the same way he claims to have turned around companies during his years at Bain Capital. The problem, however, is that the incessant debate on the merits of private equity is causing us to miss a much more important debate.
The more important question is whether the much larger public markets are functioning well and supporting an economy that delivers the kind of growth we want and need. In fact, there is much evidence to suggest that public markets are failing us.
The main shortcoming is the relentless short-termism pervasive in our public securities markets. Over the past several decades, the amount of time the average share of stock traded in New York is held by an investor has tumbled from seven years to just seven months. With this in mind, Romney and Bain cannot be accused of flipping their holdings more quickly than the average shareholder; in fact, they likely hold companies for a longer term than you and I do.
There is also the perception game that often decouples share price from real value. The trend towards more “momentum” investing and more algorithmic trading has disconnected investments from real value creation. Still, most public companies prefer longer-term investors, not traders, and a focus on long-term financial sustainability over short-term earnings helps attract these more desirable investors. For example, large pension funds, sovereign wealth funds, or foundations have longer time horizons for their liabilities and need to find investments that match those ambitions.
Paul Polman, arguably the most eloquent CEO on sustainability matters these days, has stopped giving quarterly guidance and believes that this is attracting the kind of “patient capital” that is more likely to value investments in a future that is sustainable—in all senses of the word—for his company. Many people who have asked questions about, for example, Goldman Sachs, have argued that a relentless focus on short-term profits was the direct result of the company’s transformation from a partnership to a publicly traded company. In addition, there is a long list of companies that provide steady profits but see their share price stagnate, such as GE. This kind of situation suggests that public markets are far from rational.
We have also seen multiple examples of the vulnerability of public markets to anomalies that destroy value: rogue traders, flash crashes, and securitized mortgages have repeatedly undermined the health and stability of businesses, capital markets, and households.
What’s more, the argument that private equity is ignoring the sustainability movement is no longer supportable. It has been heartening to see many private equity firms significantly strengthen their focus on environmental, social, and governance considerations in recent years. These firms have come to realize that these “externalities” are in fact a crucial dimension of their investment decisions and management approach.
Given Mitt Romney’s background, it is no surprise that his record has become a point of political debate as the U.S. chooses a president. But the overall health of the American economy--and the global economy—is shaped far more by how public securities markets operate than by the impact of private equity. Until public markets embrace long-term thinking and find ways to ensure that social and environmental impacts are considered more fully, they present the greatest risk to a fair and sustainable economy.
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