The value of any asset is determined by the market in which it trades.  The most significant component of that market as it relates to value is the relative access to liquidity of market participants.

The continued volume of RIAs selling to consolidators illustrates this.  An independent RIA is dependent on its founders for liquidity and then on successor ownership.  When successors can’t provide adequate liquidity to the founders, better valuations are offered from institutional platforms with liquidity that isn’t limited by time (founders) or financial capacity (successors).  The missing element is access to public market liquidity.

Self-Loathing

The collapse of Bill Ackman’s plan to take his closed-end fund, Pershing Square USA, Ltd., public reminded me of a central defect in the RIA investment thesis: public markets don’t like the business of investment management.

Ackman’s failure to attract public market interest in his venture is far from the only one.   The number of publicly traded investment management firms has fallen significantly over the past ten years, as listed firms have either combined for the sake of survival or gone private in search of a more receptive market.  Focus Financial found some, but not much, success as a public company.  CI Financial has thus far failed to take its U.S. wealth management entity public.  Dynasty gave up on their offering.  Alti’s share price is struggling.  The only public platform that has performed well in recent years is Victory Capital, but that’s a story for another time.

Public < Private?

One problem is the IPO market itself.

Why is this?  One problem is the IPO market itself.  As I think we all know, aside from the SPAC-mania from a few years ago, public offering activity has been sluggish since the 1990s.  Some of this may be the regulatory environment, and some may be the rise of private equity (chicken/egg).  I’ve recently heard an interesting theory that the rise of passive investing has made it difficult to attract public capital to issues that aren’t already in an index (like IPOs).

None of that explains what happened to Pershing Capital USA because Bill Ackman is pretty adept at getting attention.  Ackman recently had more luck in the private markets, selling a minority stake in his hedge fund, Pershing Square, for $1 billion, which implied a whopping $10.5 billion valuation for the firm, or more than 50% of Pershing’s AUM.  When we say that pricing of minority deals often implies terms and expectations that cannot be extrapolated to a P times Q value of the whole, this is what we mean.  At the very least, the minority investors were probably banking on growth from things like a huge closed-end fund offering, which didn’t pan out.

But just as public markets haven’t shown much interest in the RIA space, private markets can’t get enough.  Higher interest rates have diminished the volume of private equity investing in almost every sector for two years, but not in investment management.  And that volume of transactions is being driven more by the buy-side than by sellers, as new names with sponsor backing pop up seemingly every month to fund a new platform to consolidate the wealth management space.

For several years, RIA consolidation was fueled by cheap debt, compelling acquisition multiples, and AUM growth underpinned by rising markets.  Today, debt isn’t free, acquisition multiples have been bid up, and public markets have become dependent on a very narrow list of equities for growth.  In spite of the headwinds, the P.E. thesis of investing in the RIA space: sticky revenue, low capital intensity, and dependable margins, has survived the pandemic and rough market years like 2022.

The missing element was and is the inaccessibility of public market equity to cash out the P.E. investment thesis and to provide replenishment capital to do new deals.  Does it matter that there is no public liquidity option for these very large and growing private companies?  In theory, no.  Captrust just hit a trillion dollars in AUM without a public listing.  If that’s possible, why bother going public?

Credibility, Liquidity, and Value

The necessity of public market backing may ultimately lie in one word: credibility.  There is no test for value quite like a market test.  Transactions between P.E.-backed firms and independent RIAs are arms’ arms-length deals negotiated by knowledgeable parties, but when the baseline expectation of those buyers and sellers becomes the prior deals of the same parties, groupthink takes over.  Consolidator valuations of holdings without a public market reference cease to be a mark-to-market exercise and become a mark-to-model exercise.  No one has incentive to look down.

The necessity of public market backing may ultimately lie in one word: credibility.

Returning to Bill Ackman, he, too, successfully completed a transaction in the private markets for his management company based on a growth expectation that would be fulfilled by public markets.  Now that the public market has rejected his closed-end fund offering, the valuation of the hedge-fund manager looks impaired.

I’ll end with, of course, a car anecdote.  In 2022, an 84-year-old Italian race car worth $23 million was stolen.  The car, a 1938 Alfa Romeo 8C 2099 Lungo Spider, was being trailered across the U.S. when it and the truck and trailer carrying it were stolen in the middle of the night from a Holiday Inn Express.  (Such transport for valuable cars is more common than you might imagine.)

The police soon realized that the thieves probably intended to steal the truck and trailer and were not targeting the much more valuable cargo inside the trailer.  It took more than a year to recover the car, but it was eventually found in a warehouse.  (It’s available now if you’re interested.)  The thieves could have easily figured out that the payload was, theoretically, worth much more than what they thought they had stolen.  If they had discovered the value of the car, they would have also realized that it’s impossible to discreetly sell a classic car for eight figures.

Such is the nature of markets: without access to liquidity, value cannot be monetized.  But what is value if it cannot be monetized?