Visualizing History 

Source: The British Origins of the US Endowment Model

From the Archives

Successful Stock Speculation (1922)

Sunday Reads

A few weeks ago, Michael Mauboussin dropped a 90-page bombshell of a research report titled ‘Public to Private Equity in the United States: A Long-Term Look’

“Markets have become more sophisticated over time as the result of the growth in institutional money management, financial innovation, and sharply lower technology costs. Large institutional investors, including pension funds and endowments, face the prospect of swelling future liabilities and diminished expected returns for most asset classes. As a result, they have reduced their portfolio allocation to public securities and have increased their allocation to private equity, where returns have historically been higher.

From the end of World War II through the early 1970s, many companies went public to raise capital to fund their growth. Today, young companies often rely more on intangible assets and have a less voracious appetite for capital. They also have unprecedented access to capital through the private markets. Consequently, many young companies have elected to stay private longer than did the companies of prior generations.”

This was one of the most interesting research reports that I have read in a while, and today’s Sunday Reads will be structured around some of the major points discussed in Michael’s paper. In particular, we are going to dive into the historical evidence on:

  • Underpricing IPOs
  • The Profiles of Company’s Going Public
  • Yield Chasing
  • And more…

But! Before diving into all that I want to revisit a topic I covered a few weeks ago: SPACs. After reading Michael’s paper, the recent boom in SPAC listings makes a lot more sense. Let me explain.

The Individual Investor

The seismic shift in US equities from public markets to private markets has made a marked impact on the individual investor. First, they have experienced a winnowing selection of public companies to invest in, as displayed in the chart below:

Making matters worse, even within this smaller pool of US stocks the individual investor has been increasingly crowded out by institutional investors (see below):

Analyzing companies and figuring out their value has never been easy, but institutional investors are better equipped to do it than are individual investors. In 1970, individuals held roughly 75 percent of public equities and the institutional investment management industry was nascent (see exhibit 8). For example, we estimate that the number of chartered financial analyst (CFA) charterholders per public company increased from roughly 1 in 1976 to 27 in 2019.

This sophistication brought with it more complexity. Financial innovation, including option pricing models, along with rising computing power and declining computing costs, ushered in a new era of finance. This led to changes within public markets, including the rise of indexing and the migration from public to private markets.”

Although these problems facing the individual investor were not insignificant, institutional investors faced an additional problem: “liabilities have increased while expected asset returns have decreased.” This dilemma triggered an all too familiar “hunt for yield”. Mauboussin writes:

Perhaps the simplest explanation for the shift from public to private equity is the needs and demands of institutional investors. For most pension funds and endowments, the primary investors in U.S. private equity, liabilities have increased while expected asset returns have decreased. For example, a large gap has opened between the assets and liabilities for pension funds in the U.S. Estimates for these unfunded pension liabilities run from about $1.6 to $6 trillion, depending on the method and assumptions you use.

There are three levers to reduce the gap: contribute more to the plan, provide less to the beneficiaries, or generate a higher return on the assets under management. Since the first two levers are not popular, most chief investment officers strive for the third.” 

And as we all know, the method for implementing this third lever came in the form of Alternative Assets like private equity, hedge funds, etc.

“The pattern in asset allocation that we have seen is consistent with the search for returns. The left panel of exhibit 11 shows that a large sample of state and local government pension funds in the U.S., with total assets estimated to be $4.5 trillion, have increased their allocation to alternative assets from 7 percent in 1990 to 29 percent in 2019. Close to 40 percent of surveyed institutional investors plan to increase their exposure to alternative assets.

The right panel of exhibit 11 shows that university endowments, which collectively control assets of more than $600 billion, have undergone an even bigger shift. Endowments increased their allocation to alternative assets from 6 percent in 1990 to 53 percent in 2019.

The non-accredited individual investor received the short end of the stick due to their inability to access these same private market investments with more attractive expected returns. They were left to fish from the diminishing supply of public stocks in a market that was still dominated by institutional ownership, despite their increased private market allocations.

In addition, the attractive companies that many of the individual investors would want to invest in were now electing to stay private longer before going public.

Another consequence of staying private longer is that more wealth is created in the private market and less in the public market. While individuals are ultimately the beneficiary of the private wealth creation through pension funds or endowments that invest in venture capital funds, a normal individual investor is largely shut out from that source of wealth.

Exhibit 40 shows the time from founding to IPO and the market capitalization at IPO for, Google, Facebook, and Uber. Amazon, which was backed by the venture capital firm Kleiner Perkins, came public 3 years after it was founded with a market capitalization of $660 million (in today’s dollars). Investors who bought at the IPO and held their shares have made more than 1,800 times their money through June 30, 2020.

Google did an IPO 6 years after its start, and shareholders have made 33 times their money. Facebook went public 8 years following its foundingShareholders have made 6 times their money. Uber went public 10 years after founding with an initial market capitalization of $75 billion.

Virtually none of the $1.3 trillion in value that Amazon built was in the private market. Three percent of the value created by Alphabet, which controls Google, was in the private market, and that percentage was about 17 percent for Facebook. And the implied value of Uber in the private market was more than 100 percent of the total value created, as the company’s market capitalization is below what its IPO price implied.


Well, thank you for asking. To me, the points outlined above help explain the behavioral drivers behind the recent speculative boom in SPACs, EV startups, and everything else. For decades, the non-accredited individual investor has been unable to reap the benefits of private market investments offered through either Private Equity, VC, etc.

When these individual investors finally get the chance to invest in exciting names like Facebook or Uber, it is only after significant wealth creation has occurred in the private markets. Now, it is worth mentioning that there have obviously been countless examples of wealth destruction in private markets that individual investors have been shielded from (WeWork). However, I think we’d all agree that the individual investor is probably more aware of the private market ‘winners’ that they have been unable to access in the exciting and sexy world of venture investing / private equity.

Enter SPACs

After reading Michael’s paper, the recent SPAC mania made a lot more sense. While SPACs are nothing new, their resurgence as an alternative to the traditional IPO route have made them very enticing to the individual investor because they can provide the experience that they have long desired: the thrill of VC investing and opportunity to access private market companies.

Clearly, there is a laundry list of differences between VC funds and SPACs. However, I think the reason for SPACs booming popularity this year partially due to the psychological component of individual investors feeling like they can finally access an area of the market that institutions and accredited investors have benefited from for so long.

History is filled with similar examples of investment products and vehicles designed to offer retail investors greater market access. One of today’s articles dives into a 19th century example of this, but there is evidence of this even back in the 18th century with the first iteration of a modern mutual fund, which I discussed here:

Dutch financier Abraham van Ketwich is considered the father of this first mutual fund, Eendragt Maakt Magt (Unity Creates Strength), which was founded in 1774. Although it was a mutual fund, and not an ETF, the reasoning behind the invention of Eendragt Maakt Magt is similar to ETFs:

“The prospectus required that the portfolio would be diversified at all times. The 2,000 shares of Eendragt Maakt Magt were subdivided into 20 ‘classes’, and the capital of each class was to be invested in a portfolio of 50 bonds. Each class was to consist of at least 20 to 25 different securities, to contain no more than two or three of a particular security, and to ‘observe as much as possible an equal proportionality’.”— K. Geert Rouwenhorst

In essence, the Eendragt Maakt Magt was an equal-weighted index fund designed to offer investors a broad, diversified exposure across ’20 classes’ of bonds.

Occurring so shortly after the market crisis in 1772–1773, which was sparked by concentrated bets on the East India Company, some have argued that Van Ketwich’s fund was intentionally designed to offer a conservative, and more diversified fund for smaller investors. Van Ketwich even kept fees abnormally low at 0.20%, not unlike passive funds today.”

Alright, now let’s get going!

IPO Underpricing Over the Very Long Run

The most anticipated moment of the IPO process is the “first day pop” when shares first begin trading on the public markets. This “pop” has led to greater debate around the persistent underpricing of IPOs to ensure this first day pop occurs. Legendary venture capitalist Bill Gurley has written and talked about this at length, and you can watch him discuss the issue below:

This article aims to provide historical context for this very same issue, with data stretching back to 1917.

A central measure of the efficiency of the Initial Public Offering (IPO) market is the extent to which issues are underpriced. We present new and comprehensive evidence covering British IPOs since World War I. During the period from 1917 to 1945, public offers were underpriced by an average of only 3.80%, as compared to 9.15% in the period from 1946 to 1986, and even more after the U.K. stock market was deregulated in 1986. The post WWII rise in underpricing cannot be attributed to changes in firm composition, and occurred in spite of improvements in regulation, disclosure, and the prestige of IPO underwriters.”

The article even looks at the first day “pop”:

The Private Origins of the Private Company: Britain 1862 – 1907

This article looks at the historical role and influence of the private company, particularly as it relates to their decisions on going public or remaining private.

“This article recalls the fact that in Britain (and elsewhere), until the mid-19th century, neither company legislation, nor jurists or economists, envisioned companies to be private or small. Nevertheless, once freedom of incorporation and general limited liability were enacted, a new practice was set in motion. Smaller companies were formed in growing numbers, replacing partnerships, family firms and even sole proprietorships, and operated in sectors in which corporations had not been found before. These companies did not seek access to the stock markets.

The article tracks the take-up pattern of the corporate form in Britain. It analyzes the reasons for the decision of businesspersons to incorporate their small firms. It examines the reactions of the courts (in the famous Salomon v. Salomon case) and of the legislature to this unpredicted practice, which emerged from the bottom up. It argues that incorporators and their lawyers used the available contractual flexibility to privately design the Articles of Association and adjust them to the specific needs of private and small companies, often by introducing partnership internal governance rules into company Articles. Eventually, in 1907, the private company was recognized by the Companies Act. The article relies on newly gathered data on the take-up of the company form and a newly produced sample of company files. It is part of a wider collaborative and comparative project that studies private limited liability companies (PLLCs) in Germany, Britain, France and the US.”

Why Wait? A Century of Life Before IPO

“Firms that entered the stock market in the 1990s were younger than any earlier cohort since World War I. Surprisingly, however, firms that IPO’d at the close of the 19th century were just as young as the companies that are entering today. We argue here that the electrification-era and the IT-era firms came in young because the technologies that they brought in were too productive to be kept out very long. The model assumes that the stage before IPO is a learning period during which the firm refines the idea before committing to it at the IPO stage. The better the idea, the higher is the opportunity cost of a delay in its implementation, and the earlier the firm will have its IPO.”

One of the most common explanations for why SPACs have become so popular is that they represent a more enticing option for private companies looking to go public. SPAC’s provide private companies a lower cost and faster path to public markets that endures less scrutiny than a traditional IPO, since they are going public via an acquisition or merger instead of an independent IPO.

Bearing that in mind, this article looks at the long history of IPOs, and the decisions driving entrepreneurs to list their shares on the public markets. For example, the popular narrative today is that companies are staying private longer, but what has this trend looked like historically?

The Five Eras of Financial Markets

While not yet long enough to really be considered an ‘era’, the public -> private market shift is definitely a “sub-era” in market history. In this post, the author dives into 5 previous eras in financial history, and the evolution of markets over time:

“Global Financial Data has produced indices that cover global markets from 1601 until 2018.  In organizing this data, we have discovered that the history of the stock market over the past 400 years can be broken up into four distinct eras when economic and political factors affected the size and organization of the stock market in different ways.  Politics and economics define the limits of financial markets by determining whether companies can exist in the private or the public sector, by controlling the flow of capital in financial markets, and by determining the level of regulation that companies face in maximizing their profits.”

Go Active or Stay Passive: Financial Innovation and Underdiversification

In 1836, Société Générale launched the world’s first closed-end equity fund with the intent to provide a cheap source of diversification for small investors. Article 2 of the fund’s prospectus stated:

‘The company’s purpose is to present to the investors “a placement of the social capital in a large number of establishments” to have protection against reverses that one of the establishments might experience momentarily.’

This article by Gertjan Verdickt and Jan Annaert analyze whether these small retail investors were better off managing their own portfolios (Active Management), or buying into an investment trust like the one offered by Société Générale (Passive Management). It is important to remember that these trusts were designed specifically for small investors.

The paper’s conclusions are quite fascinating, and provoke broader thoughts on the markets accessible to small and wealthy investors. For the results in this paper demonstrate that the more expensive shares (in nominal price, not valuation) outperformed the market. However, these shares were not available to smaller investors, who could not afford the steeper prices. For example, not many people can afford to buy a whole share of Amazon stock costing ($1,700). The chart below shows the difference in returns between Cheap and Expensive shares.

This notion of higher alpha in markets only accessible to wealthy investors is comparable to the classification of ‘Accredited Investors’ today, who can access Private Equity, Venture Capital, Hedge Funds, etc.

‘We choose this metric since it is easily observable, comparable and important for less-wealthy investors. Arguably, less-wealthy investors were only able to choose from stocks with low nominal prices. If these investment trusts were truly targeted towards smaller investors, they would be able to outperform lower-priced stocks.’

The investment trusts offered to small investors offered better performance than individual stock picking of Cheap shares, but wealthy investors with access to Expensive shares were better off staying ‘Active’.

Private Capital, Public Credit and the Decline of American Railways in the Mid-20th Century

“From the mid-19th Century until the Great Depression, banks, insurance companies and other large institutional investors supplied railways with external capital that supported their rise to near hegemony over transport in the U.S. This regime ended in the 1930’s, when widespread rail bankruptcies threatened broader credit markets. The federal government intervened via a powerful, new, public financial intermediary—the Reconstruction Finance Corporation—to socialize devalued rail debt, which largely removed private institutional investors from rail capital markets. At this defining moment, the Roosevelt Administration could have used its financial and political leverage to rationalize structural weaknesses in the rail industry. It did not. Thus by the time the Depression ended, railways were significantly weakened vis a vis their increasingly successful competitors in highway-based transport. Thus, the decline of American railways was caused more by financial factors than, as existing historiography suggests, by either excessive government regulation or failures of railway management.”

Who were the key investors in this industry, you may ask?