Investors First: Benchmarking the Modern Market

Kunal Kapoor: Good morning, everybody, and great to have you here joining us for the latest in our LinkedIn Live series. I’m really excited about this one because we’ve been talking in some of the past conversations about the rise of private markets and the intersection with public markets. What we haven’t done a whole lot of is talk about what it actually means when it comes to basic things, such as how you build a portfolio, how you benchmark a portfolio, what it means for the future profile of returns. And we’re going to try to spend some time today doing that and trying to unpack how it’s all playing out.

I’m joined by three of my stellar colleagues today. Sandy Beharry, who’s associate director of private market Indexes at Morningstar. Eric Compton, who leads equity research, is one of our leaders in equity research. And Paul Condra, who’s global head of private markets research within our PitchBook business. And so great to have you all here. Thanks for joining me. And I’m going to start with you, Sandy, with just a simple question, which is, what sort of was the defining reason why we went ahead and built the Morningstar PitchBook US Modern Market Index? And how does it actually align with the vision that we have of helping investors navigate this emerging trend/marketplace?

Sandy Beharry: It might be a simple question, but there’s a large reason why we did this. At Morningstar, we’re always trying to equip investors with tools to help them better make decisions. I think that when it comes to indexing, for decades, they’ve been designed to measure public markets. And that went well when companies listed earlier in their lifecycle. If you’re an investor who was tracking or analyzing a public benchmark, you had a really good idea what the economy, what the market sentiment, and what the full investor opportunity set looked like. However, the markets have evolved. Companies are staying private longer, with the average age to IPO at about 12 years, when it was six years a decade ago. And that’s because companies are able to raise a substantial amount of capital without ever going public.

In fact, some of the largest and most innovative companies are choosing to stay private. Let’s take OpenAI, for example. Earlier this year, the company raised $40 billion in a private funding round. And to put that into perspective, that’s twice the size of the largest IPO in history. Even more recently, Nvidia NVDA announced they’re going to inject another $100 billion. That’s a massive amount of capital flowing into a single company that doesn’t appear in any of the indexes that most investors are using on a daily basis. And this trend we’ve observed has been happening over years. Back in 2000, privately held venture capital-backed companies made up maybe 1% of the total equity market. But today, that number is somewhere between 8% to 10%. So, that is not fringe anymore. That is a material shift.

However, benchmarks have not kept up. They continue to track only public markets, so they’re really missing out on a significant and growing portion of our economy. Because of this, we’ve really observed three challenges. The first being that benchmarks are incomplete. They are no longer representing what the full investor opportunity set is. The second is that innovation is underrepresented. Because the companies that we’re missing in these public benchmarks are the ones that are transforming the economy. And different verticals like artificial intelligence, fintech, biotech. And another challenge that we’ve observed is that investors are really lacking in transparency. Because without consistent data on private companies, it makes it really difficult to measure them or to compare them with their peers. This is pretty much what we look to solve for with the Modern Market 100 Index.

Kapoor: So, we’re basically trying to address the realities of the way the market has evolved. And Paul, question for you is, how do we think investors are evolving? And how do you think they’re going to respond to the launch of indexes like this?

Paul Condra: First, thanks for having me. But I think it depends on the type of investors we’re talking about, right? On the institutional side, you’ve had a lot of that hybrid investing for several years, where they’re looking at more exposure to private markets. But I think what’s new this time around is really trying to tap into the retail side and the wealth side. And so to do that, you need to be able to tell the story of what’s happening in private markets more clearly and make it easier for those investors to understand what step my exposure is going to look like if I do allocate into private markets. And so I think indexes like this are one way that we’re going to be able to do that, right? It’s one way that a financial advisor can go to their clients and say, “You know, look, if you actually put a little of your portfolio into late-stage startups, and we have some products that can help you do that, this is kind of what your performance is going to look like relative to what you did if you just kept it all in public equities.”

So, that’s really important in order to grow that funding source. And I think we’ve seen that there is demand on the retail side as well. Like Sandy was talking about, companies are staying private longer. A lot of the growth and innovation is happening in these late-stage startups. So, there’s real demand on the retail side to get more exposure to that. And so there’s more interest to find these types of private market vehicles and find these techniques or ways that I can get exposure through those traditional wealth channels.

Kapoor: Eric, last night I read an essay that Andrew Sorkin penned in The New York Times, or maybe it was The New York Times Magazine. And his argument was essentially that we should be skeptical about this emerging trend, because I think he appropriately raises the specter that retail and wealth are kind of coming to this game late. And part of what is happening here are that institutional asset owners and the like have been investing here for a while, and they’ve run out of capital to put into these types of investments. And so the PE firms are starting to look beyond just their traditional areas.

Do you kind of at a high level agree with the thesis that it’s perhaps more risky? And then also, given that there is some opportunity, though, as we’ve laid out, how should we think about transparency here? You’ve obviously navigated the public markets for a long time. What needs to change in the private markets for investors to feel more confident?

Condra: Talking to the risk side of it, we’re at an interesting point in the cycle where there’s not a lot of exits happening in private markets. It does seem like trends are moving in the right direction. But at the same time, there’s more capital being raised from the retail wealth channel than ever before. And those investors are expecting some exposure to these markets. So, while fund performance is actually down, the ability to raise funds, not an institutional level but just through retail wealth channels, is actually up significantly.

So, there’s potentially a lot of money right now that’s chasing opportunities that might be a little more scarce. That’s just looking at like private equity and venture, right? We also have credit and real estate and infrastructure. And I think there’s probably more ways to put money to work there. So, I don’t think you’re going to fully avoid the cyclical impacts of being exposed to privates. And I think that’s probably something that retail investors are going to have to understand. But I also think there’s going to be a willingness to kind of look through that. And if you’re willing to have a long-term perspective, you’re going to realize those benefits. But that is the inherent risk.

The retail and wealth channels are just typically not going to always have a 10-year cycle. They’re going to be wanting more liquidity. That’s going to impact the type of returns we’ve seen historically. It doesn’t necessarily mean that type of return profile is going to translate directly to a retail investor. And then I think on the transparency side of it, we just don’t have pricing on private assets on a day-to-day basis. Some of them we do, but a lot of them we don’t. And you don’t have necessarily performance of those assets as well. This is an interesting place where I think Morningstar can play an interesting role as kind of a neutral, objective provider of information or an index like Modern Market 100, where we have developed a methodology to provide you an index that, to the best of our ability, provides a view of pricing into that part of the market. And I think we occupy a position in the market where there’s trust.

So, I think it’s going to come down to who’s providing these kinds of vehicles, these types of private market exposure. How much do you trust them? What is the process by which they’re getting this information? Anyone can go to CNBC and look at pricing history of any public company you just can’t do that with private assets. So, the flip side of that is that as you build more transparency into private assets, do you then lose some of the illiquidity premiums that maybe existed in the past? There’s a little bit of this sort of give and take, I think, in terms of you want to retain the value of a product that’s privately traded, but you also want to increase some level of transparency, some level of visibility, so that people have some comfortability with owning it.

Kapoor: Eric, you want to jump in, and so maybe you can do that, but maybe I’ll modify my question a little bit to say, how has this impacted the framework that you as an equity researcher have been using, and what does it mean going forward in terms of how you think about comparing public to private markets, how you think about comparing companies, what those frameworks look like for those who are research first?

Eric Compton: Sure, so just to echo a lot of the points Paul mentioned. There’s always that trade-off, public versus private, with things like transparency, real-time price discovery, and liquidity. And so you’ll probably, over the long term, see different companies make different choices along that continuum, where before maybe you had private/public, and then maybe there’s more optionality to make choices along that continuum for these different companies to get greater access to retail investors, which might have different needs. The other thing I’d say on that topic is at the end of the day, fundamental analysis and investing in good companies and knowing what you own, that’s going to matter, public versus private, that’s going to matter regardless of funding dynamics, things like that. That’s, I think, another thing we always try to keep in mind, especially at Morningstar, empowering people to make decisions based on good information fundamentals.

Now, as it relates to the different frameworks that come into play for public/private, I spend a lot of my time focusing on individual equities, but certainly we do have conversations with PMs who have to think about what are they benchmarked to. So, the benchmark conversation does come up. And I would say one meta theme, as you think about as the universe of opportunities increases, and benchmarks begin to match that, I think the return structures of some of these investments also start to change. So, I mean, just looking at these companies that are in the US Market 100 Index, the 10 privates, over half of them are AI-related names. And so that’s very, I would say, heavy, right-tail skewed, embedded optionality, power law return structures. That’s going to come into play more and more. You’re also seeing that come into play more and more in public equities. But again, as an investor, those are things you need to be thinking about. What sort of return structures are you engaging in, and are you aware of the inherent upside but also the risks at play?

Kapoor: The correlation is higher than people make it out to be because you have the public markets being led by a handful of AI companies, and private markets, the benchmark is showing that there’s something similar afoot.

Compton: If you think about diversification and weightings, in a lot of ways, diversification actually lessens, and that can be on a sector basis. It’s more weighted in technology. It can be on a thematic basis, more weighted in AI. You could say it maybe increases diversification on a company-maturity basis, so you’re getting more access to earlier-stage companies earlier in the innovation cycle. Depending on which framework you want to analyze it with.

Kapoor: vis-à-vis all the benefits that Sandy talked about earlier, but as you and Paul have pointed out, the markets are changing enough that perhaps the correlations are going to be on the rise. And we’re starting to get a couple of questions from those of you who are participating, and I appreciate that. Please do send in your questions. I’ll start to weave them in. And one of the questions, Sandy, that has kind of come in, and I’ve got a little bit of a slightly differentiated take on it, is how do you actually account for valuation differences between public market data, which is frequent and liquid. If I open up my Morningstar app here on my phone, I can immediately get access to all that data vis-a-vis the private market data, which is not as transparent. And so even if we look at the performance of this index since its launch, what are we finding so far?

Beharry: Good question. I would say that pricing definitely was our biggest challenge. It really is the complexity trying to reconcile to fundamentally different pricing ecosystems. As you mentioned, public companies, they trade in real-time consensus on official exchanges. Private companies, they operate in suspended animation with valuations often set by funding rounds that occur on average every 12 to 18 months apart. However, secondary markets provide a way for early investors or employees to realize the value of their investment prior to an IPO occurring. And this is not your traditional private equity with stagnant capital. There are active secondary markets that have transactions occurring on a daily basis, essentially setting intermediary prices for these companies in between their funding rounds.

So, we’ve created a robust model that integrates multiple secondary-market data sources. It’s able to then separate signal from noise. And we then calculate a single consolidated market price on a daily basis for a private company that’s not only reliable, but it’s representative of real trading values. When we look at the performance, the index has performed well over time, and it outperforms its benchmark as well. Because when you compare it to its benchmark, which essentially is the public companies within the index. You expect the correlation to move somewhat in line, but then the outperformance that you’re seeing is due to those private companies that are really driving up the returns.

Kapoor: And just to sort of build on that, Paul, what improvements would you like to see in terms of transparency that would make the index a little bit more robust?

Condra: I guess to add on what Sandy was talking about as well, especially we’ve seen this volatility in the market over the last couple of days. And so when you look at our kind of hybrid index that includes private companies, it’s much smoother. So, that’s part of the noncorrelation benefits of having that private market exposure. You’re really not getting those price points on a daily basis for private companies. And so they’re not gonna express the same kind of volatility through the index that your public companies do. And I think it’s probably going to be a constant iteration of how do we explain the methodology of how we’re pricing these assets more clearly over time. Some of it is, I think, the value of IP and being a trusted provider of we’ve figured out a way to do it, and we want to build trust that what we’re doing is accurate and reflects how those companies should be priced or how they would be priced in the market.

But then part of it is we need to give our users some visibility into that process so that they can understand, and they can verify and audit it in their own ways as well. Right? And so, like I mentioned, you would want more liquidity so you have more price points. But then you might want some other models that we can talk to about how we’re maybe estimating valuations or estimating trends based on some financial points that we do have. And all of that could kind of just feed into overall how we’re presenting the package.

And over time, I expect that as these markets mature, if you’re a late-stage startup and you want to stay private, and you want to continue to raise capital, you’re likely going to have to disclose a little bit more information about your company if you want to keep attracting investors, especially investors willing to put together the large amount of investments that we’ve seen these companies do. And that’s what I spoke about earlier, where you maybe lose some of your illiquidity premium, but you’re making the market a little more transparent and visible, so you’re attracting more investors to the market. And that just makes it a little deeper and more liquid.

Kapoor: Paul, there’s a question here from one of our viewers who’s asking, what makes our datasets within PitchBook particularly unique and appropriate for the work at hand?

Condra: Well, we’ve got a lot of private-company data and a lot of public-company data. So, in terms of the public-company data, there’s nothing really unique there, right? We can do all the valuation work on those public companies pretty easy. And on the private side, we capture a lot of data points for these private companies that they may release through press releases. It may be public information, but what we do really well is capture that data in one place, and we can put it into our methodologies and our algorithms that allow us to enhance the valuations that we’re producing. Then we also have partnerships with secondary brokerages where we can get pricing information, and that can factor into the way we’re pricing these assets, too. And we’ve got other work that we’re focused on to continue to advance how we can put valuation on private companies. I don’t know, maybe Sandy has some more detail on our methodology also in terms of how that’s factoring into the index.

Kapoor: Sandy, before you go into methodology, there’s a question here about whether there’s survivorship bias, because we’re saying that private companies have performed better than public. But the viewer is asking, well, we’ve picked the private companies that are most prominent today, so doesn’t that lead to survivorship bias?

Beharry: Well, the index is supposed to represent the leaders on the public and the private sides that are really driving our economy. So, yes, it does include 90 of the largest publicly traded companies that are US-based. But it does also include 10 of the largest privately held late-stage venture capital-backed companies. It’s selecting based on size because we are trying to represent the true leaders of the economy on both sides that are really driving innovation. So, I think that the index is actually doing what it is intended to do. And having these large companies in there, it’s providing investors with exposure to companies that they never would have been able to get access to if they were just tracking a typical public market index.

Condra: I think I would add that survivorship bias is kind of a characteristic of most indexes as well, right? I was going to say, exactly.

Kapoor: Exactly. The larger, in a market-cap situation, do end up owning more of the index’s overall assets. Eric, can you talk a little bit just about some particular companies that you’re tracking within the index, and what in particular has drawn you to those sets of companies?

Compton: Sure. So to me, the theme that jumps out when I look at this index that so many of the companies, particularly the largest ones, are representative of is the meta theme of AI. That includes the public companies where you’ve got Nvidia, the hyperscalers, Broadcom AVGO, and all those companies are just central in both the hardware side of the AI buildout, but also just the cloud infrastructure demand side of that buildout. But then on the private side, you’ve got OpenAI, Anthropic, xAI, even Databricks, I’d say is pretty strong on the AI theme. You could make the argument, depending on what factors you want to look at, OpenAI is potentially the most important company in the world right now. And a lot of that has to do with the future of AI for the economy, for technological development, et cetera. So, to me, when I look at these companies, AI is the big thing that jumps out. And how do I track them or why do I track them as the technology sector lead, probably is not a surprise. I spend all day thinking about AI. And this index, I think, gets at the heart of that.

Kapoor: How has the availability of this index changed how you go about solving what you just talked about?

Compton: I wouldn’t say the index itself really changes my own personal research workflows. For that, it’s researching the public companies and then staying aware of the private companies. I mean, shout out to the tools on PitchBook, right? We do use those every day. You’ve got to be aware of what’s going on with OpenAI. You’ve got to read a lot of their releases, technical papers, et cetera. And so I think for me, the index is really going to come up more if you’re a PM or a financial advisor, and you’re having discussions about asset allocation, or you’re thinking about benchmarks, in my own day-to-day job, when that comes up in conversations, that’s I think going to be more relevant.

Kapoor: We’re almost at time here. I’m going to ask a final question. If each of you could give a brief response with your thoughts, that would be awesome. But let’s end on this. Could the blending of public and private companies into single benchmarks set a precedent for other asset classes or markets globally as well? Sandy, why don’t you start?

Beharry: Yeah, sure thing. I think definitely. The modern market 100 was just the first step that we’re taking and redefining the total equity landscape by combining public and private companies to try to really reflect where capital formation is happening today. And I think the US was just a natural starting point just because it has the most mature and the deepest private market ecosystem. But that logic, it applies globally as well. And we’re seeing in regions like Europe and Asia, they already have really strong private market ecosystems there as well. And they have companies there that are late-stage that are starting to scale. So, as secondary markets in those other areas start to deepen as well, it’s a natural extension to bring them into companion benchmarks. We do think that this is a global trend that we’re seeing. And looking forward, we are focused on creating a global family of modern market indexes so that investors everywhere can see the true picture of what modern markets actually look like.

Kapoor: Great.

Compton: Eric? Go ahead, Paul.

Condra: All right. Thanks. Yeah. I would tend to agree with that. Maybe what I think would be an important next development would be the development of more kind of investable products around these types of indexes that we’re creating, right? The thing with a blended index like the Modern Market 100 is you can’t own the constituents very easily. You can own the public side. You can’t really own the private side. So, how do we create kind of synthetic structures that give you that exposure through the use of derivatives and options and whatnot? And I think this just is another step along the path of ETF innovation. You can create those types of products. There are already types of hybrid ETFs out there that give you exposure to things like real estate and credit. So, you can get private exposure in other ways.

I think there’s opportunity to have more kind of dynamic ETFs that maybe change based on the outcomes of certain events. I think that could be the next stage. So, the blending of private assets across different types of private assets along with public, and then more just innovation in the structure of ETFs, I think that’s just the future of investing. It’s a way of providing more investors with an ability to get the exposure to the things that they want, and it’s not so much about I need to be in private, or I need to be in this kind of asset class. It’s more, I have a certain investment outcome I’m trying to achieve, I have a perspective, and what kind of tools are going to allow me to do that. And I think this is just another step in that path of just providing more of those tools into the market.

Kapoor: Great. Eric, final word.

Compton: All right, final word. I think if I divide this into institutional versus retail, as I think about it, I think on the retail side, for sure, it can be a catalyst to the extent it leads to more conversations between advisors and their clients. Here are the types of returns you see when you add private exposure. I think it for sure could increase demand, particularly if the returns are good, it can increase demand for those types of assets. And then it increases demand for the types of innovation that Paul was referencing. And then to me on the institutional side, it feels more like an acknowledgment, I guess, of trends that have already gone on. And so markets have already evolved, I’ll think a long way on the institutional side, increasing private exposure. And so to me, this is, as those markets change, this index fits squarely in that momentum of more acknowledging a lot of the change that’s already been occurring.

Kapoor: Awesome. Thank you. Thank you, three, for joining me today. And thanks to everybody who jumped into this LinkedIn Live. I thought it was a great session and lots more to come on this fast-developing topic. Thanks, everyone. Hope you have a good day.