Discover more from Alt Goes Mainstream by The AGM Collective
AGM Alts Weekly | 8.27.23
AGM Alts Weekly #16: Making private markets more public, every week.
👋 Hi, I’m Michael and welcome to my weekly newsletter, the AGM Alts Weekly. Every Sunday, I cover news, trends, and insights on the continuing evolution and innovation in private markets. I share relevant news articles, commentary, an Index of publicly traded alternative asset managers, job openings at private markets firms, and recent podcasts and thought pieces from Alt Goes Mainstream.
Join over 2,100 thought leaders from top private markets firms like Blackstone, Goldman Sachs, Apollo, Fidelity, iCapital, Franklin Templeton, and more.
Join us to understand what’s going on in alts so you and your firm can stay up to date on the latest trends and navigate this rapidly changing landscape.
Good morning from LA, where I’ve just come back from a good friend’s wedding in SF. He happens to be an institutional LP in VC and PE funds, so any wedding related, VC-themed jokes about the forthcoming topic, the power law, are welcome and I’ll relay them to him.
The power law. An oft-discussed term in venture capital — and one that has been canvassing the social media airwaves over the past week. VenCap, a long-standing institutional LP, gave people a look under the hood about what power law really means in VC.
VenCap’s Dave Clark generously shared data from their fund commitments from 1986-2018. That data set represents 11,350 companies across 259 funds. It’s worth noting that VenCap is a LP in many of the top-performing, brand name VC funds.
Here’s what they found:
If there’s a chart that captures the power of the power law, it’s this one.
Just 1.1% (or 121 companies) of the 11,350 companies across all of their fund commitments produced fund returning results.
This shows just how difficult venture capital is to find truly outlier companies. Finding, picking, and winning investments into power law companies are few and far between. Which makes it all the more important that VCs give themselves every advantage in sourcing, picking, and getting into the best companies.
Sure, funds can have strong fund performance with solid (3x, 5x, even 10x investment outcomes at the company level), but in a world of outliers, it’s outlier performance that really moves the needle for both GPs and LPs.
Clark states that continuing to invest into those outlier companies often proved to be a prudent decision for those funds.
Let’s lay it out. What are the takeaways for both GPs and LPs?:
1/ Finding true winners is an extremely hard endeavor.
2/ This data makes sense of why VCs spend so much time focused on doing everything they can to drive returns with their winners. It’s the compounding effects of the power law that drives returns.
In a world where finding and picking an outlier company is probably the single most important decision a VC can make in any given year, it explains why VCs are increasingly spending money to gain every advantage they can to leverage all the data they can to find companies that could be the outliers.
I expect data-driven approaches to VC to continue to become increasingly popular as the ability to utilize data to make better investment decisions continues to improve.
3/ There’s a saying in VC that your “fund size is your strategy.” This appears to be true for the most part. It’s often made LPs infer that smaller funds therefore have a better chance at returning their fund because they don’t need as large of an outcome (depending on ownership size) from an investment to return their fund. Clark, however, has an interesting datapoint here. He finds that within their dataset, VenCap had several $1B+ funds that had fund returners.
4/ How should allocators digest this data? Certainly, having exposure to tech’s biggest winners will generate fantastic returns for investors. It’s also well-understood that as the universe of public companies shrinks — and more companies are staying private longer — much of the value is being captured in private markets. This would suggest that LPs should look to have some level of exposure to private markets in order to have the potential exposure to outlier companies. It can be hard to pick VC funds, particularly without access to the top performing funds, but it’s worth the effort due to the impact it can have on returns.
5/ It’s worth noting that there’s nuance to this data — having a high performing, top quartile fund and having an outlier company or fund returning company in a portfolio are not necessarily mutually exclusive. Without knowing VenCap’s portfolio, it would be interesting to find out if there were funds that hit 3x+ net MOIC without having one (or more) company that returns an entire fund. While less likely and certainly more difficult than doing so with a fund returner, it is still a possibility. Having a company that can return a fund in the portfolio certainly makes the path easier to achieving outlier fund performance, but it would be interesting to see if LPs have found within their datasets whether or not it is a prerequisite to successful (3x+ net) fund performance.
The other nuance here is that the job of a LP is to pick fund managers who can consistently and repeatedly produce top performing funds. Just because a fund manager finds one fund returning company doesn’t mean they will do so again. Sure, doing it once makes it easier for the flywheel effect of success begetting success due to brand and reputation to take hold, but it doesn’t mean it will happen.
6/ Achieving outlier returns means having the patience and duration to wait for outlier returns. Jamie Rhode from Verdis, an institutional family office LP that’s made almost 50 LP commitments, shared an interesting statistic a few weeks ago on datapoints from their first 20 commitments in their seed fund portfolio (full post on LinkedIn here):
“The last 20% of time produces 45% of the return of an asset compounding at 25% annualized. That means if you can compound an investment at 25% for 12 years it would produce a 14.6x, but if you sold at year 9.6, you’d get an 8.5x.”
This data underscores the point that much value is being captured in private markets — and investors have to have the patience to wait if they want to compound truly outlier returns. This point is relevant for both GPs and LPs, particularly as private secondary markets become more popular.
7/ There are many different ways to make money in private markets — for LPs and GPs alike. VC is inarguably the most difficult way to do so. VCs, whether by choice or by structure, have chosen to play the game in hard mode. From a management company perspective, VCs generally have much lower AUM than their private equity and private credit peers. So management fee streams and fee-related earnings are generally significantly lower than private equity funds. And, it’s the hardest to generate massive returns on the carry streams because outlier companies are so few and far between.
So, what’s the punchline? VC is hard? Being a truly elite investor in any corner of the market — public or private — is far from easy, but VC is certainly a much harder road to hoe than in other areas of private markets. Loss ratios in VC are higher, but the grand slam potential *can* potentially make up for higher losses, if investors pick right. Being right is hard, but everyone is rewarded when they are really right.
AGM has created an Index to track the leading publicly traded alternative asset managers.
Some of the industry’s largest alternative asset managers are publicly traded — and their net inflows can serve as a window into how private markets are being perceived by investors and allocators who are allocating capital into alternative investments.
Of note, Searchlight acquired Gresham House, a sustainability focused asset manager for $614M. This acquisition underscores the trend of larger asset managers looking to acquire specialized areas of expertise or specific strategies to build out their investment platforms and fee-related earning streams.
AGM News of the Week
Articles we are reading
📝 The Next Microsoft May Be Worth Billions Before It Goes Public | Jennifer Lea Reed, Financial Advisor
💡Private companies are staying private longer. This trend has created a number of knock-on effects that has had meaningful impact on both public and private market investors. There are many more private companies than public companies, which means that investors want to capture the value of companies in private markets. 739 companies went public in 1996, with an average age of five years. In 2022, 181 companies went public, with an average age of 13 years. Kelly Rodriques, CEO of secondaries marketplace and data provider Forge, said, “This is a big shift. So they’re going public at billions when they were previously going public at $500 million.” As companies are staying private longer, more of the value is being captured in private markets. This is forcing investors to look to private markets, and secondaries in particular, as a way to gain exposure to the value creation occurring with private companies. “The Microsofts of 30 years ago, they’re not going public anymore at the early stage. So who has had the opportunity to enjoy that dramatic growth of those early-stage companies? Well, the big institutions like CalPERS and CalSTRS, because they’ve had the ability to invest in private equity,” Michael Bell of Primark Capital said. “Our focus is to make those private-market investment opportunities available all investors.”
The evolution of market infrastructure in private secondary markets is also a driving force behind more investor participation in the space. “Even if you saw a couple of big IPOs, I don’t think it takes away the opportunity because a lot of these companies are able to stay private longer because they can get capital, which means they control their destiny better,” said Tony Davidow, senior alternatives investment strategist at Franklin Templeton Institute, an independent investment research hub in San Mateo, Calif. “When you go to the public market, it’s a different beast. You’re beholden to shareholders and meeting quarterly earnings and revenue calls, and it changes the way you run your business.”
AGM’s 2/20: The phenomenon of private companies staying private longer has had a major effect on how investors approach investing in both public and private markets. With the majority of value now being captured in private markets, investors have had to shift their mindset about where and how they decide to gain exposure to startups and innovation. The evolution of market infrastructure, particularly with technology that has enabled secondary private markets to grow and thrive, has played a role in this shift. There are now avenues for employees and early investors to achieve liquidity without companies going public. This is a positive development for early investors, employees, and founders who want to continue building in private markets, but it does raise questions about how those who have generally been boxed out of private markets due to regulatory constraints or have focused on investing in public markets gain access to the value creation occurring in private markets. We are seeing this innovation happen in real-time, as private equity funds and investment platforms are now unlocking access to investors at lower minimums thanks to infrastructure that’s enabling GPs, LPs, and wealth advisors to manage the administrative burdens associated with private markets. We’ll likely see continued innovation here, so that many investors can now capture the value of the next Microsoft, which will likely achieve most of its value, in private markets.
📝 There Was One Bright Spot in Private Market Fundraising | Hannah Zhang, Institutional Investor
💡 Fundraising has been far from easy for many funds over the past two years, with the exception of one category: private credit. Private credit funds have raised $98.9B in the first half of 2023 according to PitchBook’s latest private market fundraising report. This figure puts private credit funds on track to raise over $200B for a fourth consecutive year. Private credit funds have carried the mantle for 2023 fundraising in private markets, accounting for almost 20% of the total capital raised in private markets. PitchBook Senior Strategist Hilary Wiek points to rising interest rates as a tailwind for private credit funds, as it enables banks to earn returns on lower risk lending areas, leaving a window for private credit funds to fill a role as a non-bank lender at higher yields. While private credit funds have experienced fundraising success, venture and private equity fund managers have had a much tougher time attracting capital from investors. VC funds raised $77.7B in the first half of 2023, significantly lagging behind fundraising pace from the last five years. Private equity funds haven’t fared much better. PE funds are also unlikely to catch up with their fundraising levels from the prior year as well. An interesting development with both VC and PE fundraising is that the mega-funds ($1B fund size or greater) have not been as popular with LPs, as many LPs have seemingly focused on smaller funds. While fundraising, particularly for smaller funds, is by no means easy, this datapoint does provide a glimmer of hope to funds who are in market. Real estate fundraising reflected the opposite dynamic, with half of the $58.3B raised coming from Blackstone Real Estate Partners X Fund, illustrating that investors prefer “trusted and familiar names” in the space.
AGM’s 2/20: Fundraising statistics can tell a story — and quite a story they tell in 2023. It’s been widely covered that fundraising has been a challenge for many GPs given the shift in market conditions. It’s no surprise that private credit appears to be popular for many investors given the industry dynamics and flight to yield. This phenomenon is particularly true in the wealth channel, where, anecdotally, many investors are looking for yield and ideally looking to avoid long lockups with their fund commitments. This sentiment points to private credit continuing to have success in fundraising for the foreseeable future, particularly as it does not appear that rates will be lowered soon. It was interesting to note that smaller funds have had some success fundraising in VC and PE relative to mega funds over this past year. Anecdotally, this datapoint is a bit of a surprise to me. Many smaller and emerging managers that we’ve come across have certainly found fundraising to be more challenging — and not necessarily due to their performance or backgrounds. So it’s encouraging to hear that smaller funds appear to be having some success in a tougher fundraising environment. I, for one, am excited by this because we’ve found that it’s generally emerging and smaller fund managers who can drive outperformance due to fund size (we’ve had a number of these cases in our portfolio to date) — and I’m always a fan of the underdog.
📝 Blackstone revives retail buyout fund launch after redemption turmoil | Antoine Gara, Financial Times
💡Blackstone continues to focus on working with the wealth channel, even after challenges with its flagship $67B real estate fund, BREIT, reports the Financial Times’ Antoine Gara. Blackstone is reviving plans to launch a private equity fund tailored for the wealth channel after a months long delay. Later this year, Blackstone will resume its efforts to take subscriptions from the wealth channel for the Blackstone Private Equity Strategies Fund, BXPE. This product will bring the foundations of Blackstone’s business, corporate buyouts, to the individual investor. Efforts were put on hold after BREIT encountered challenges with redemptions earlier this year, underscoring some of the challenges and nuances of dealing with the wealth channel as opposed to the institutional channel. The fund is expected to be Blackstone’s most complex product yet. Unlike BREIT and BCRED, Blackstone’s private credit fund, which both provide regular distributions to investors, BXPE has not announced that it will provide a regular dividend. The fund is a perpetual vehicle, giving Blackstone the flexibility to sell assets at its discretion, which also means that there will be more limited liquidity features for investors. The fees are lower than historical private equity fund fees of 2/20, coming in at 1.25% management fees (after a 6 month fee holiday) and 12.5% performance above a 5% annual hurdle rate.
AGM’s 2/20: Blackstone’s efforts in the wealth channel underscore a few key challenges with working with individual investors instead of institutional investors. As we saw with BREIT, the wealth channel has complex needs and nuances with how they invest (and hold assets) that manifest itself in terms of how products are structured and distributed. Properly structuring investable products for the wealth channel require a lot of thought about both investor behavior and the infrastructure required to support investors post-investment. Blackstone has led the way when it comes to focus and efforts in engaging the wealth channel through product construction, distribution, education, and internal team construction — and the launch of BXPE further reflects their commitment to this LP base. It remains to be seen if BXPE won’t face issues as BREIT did a few months ago, but is good to see continued product innovation for the wealth channel. It’s also worth noting that fees on this product — at 1.25% management and 12.5% carry are lower than the historic 2/20 fee structure. That’s also of note for private markets — does it mean that the days of 2/20 are over? Or, perhaps, they’ve been over for quite some time.
📝 Allocators Aren’t Happy With the NAV Lending Craze | Alicia McElhaney, Institutional Investor
💡The business side of alternative asset managers is increasingly coming into focus for LPs. As private equity firms ramp up their usage of net asset value (NAV) loans, LPs are voicing concerns about transparency and what the leverage means for their funds. NAV loans, which are revolving credit facilities backed by a private equity fund’s portfolio, have become a tool for GPs to use as they face both fundraising and distribution challenges. They’ve used NAV loans to support portfolio companies, pursue add-on acquisitions without calling additional capital, and offer cash distributions. Now, some institutional LPs are concerned about NAV loans, particularly as rates rise. According to Andrea Auerbach, Head of Global Private Investments at Cambridge Associates, her team focuses on a manager using leverage at both the portfolio company level and at the fund level. “That’s leverage on leverage,” she said. That can restrict the growth of portfolio companies in the fund, Auerbach explained. Neil Randall, head of private equity at Teacher Retirement System of Texas, said “NAV loan utilization is an underwriting consideration for PE commitments. We don’t like seeing them, particularly at current rates.” LPs are worried about the layering of risk associated with NAV loans: One anonymous partner said, “I don’t want to collateralize one company with another. It feels like an unnecessary risk.” Crucially, NAV lenders are senior to investors in the capital structure. Allocators are also concerned that some GPs could use NAV loans to juice IRRs through shorter-time horizon investments, which would increase incentive fees paid to managers.
AGM’s 2/20: NAV loans are raising questions — and LPs are asking them. The market for GP solutions has been there for quite some time — banks and funds have built businesses out of NAV lending and GP staking. And that space is growing as the business of asset management itself becomes more well-understood. But LPs are raising issues with a certain corner of the GP solutions market: NAV lending. It appears that LP concerns are well-founded. There are a number of issues with NAV lending from a LP’s perspective. NAV loans can add a layer of leverage at the portfolio level, increasing risks for both GPs and LPs, particularly when companies in the portfolio underperform. There’s valid concern that collateralizing one company with another adds undue risk for LPs. There is some nuance to this argument, however, particularly when it comes to distributions. With distributions running lower than the long-term average, NAV loans can provide a way for GPs to provide distributions to LPs. So, net-net, as with many things in private markets, there’s valid arguments on both sides of the table.
Podcasts we are listening to
📝 Lee Ainslie - Hedge Fund Maverick on Patrick O’Shaughnessy’s Invest Like the Best | Patrick O’Shaughnessy, Invest Like the Best
💡 One of the best podcasts I’ve listened to in a while. Ainslie shares valuable insights about how to build an investment firm and O’Shaughnessy teases out so many good perspectives on how Ainslie approaches both investing and running an investment firm.
Who is hiring?
In order for alts to continue to go mainstream, we need the best talent to go into the space. Here are some openings at private markets firms. If you’d like to connect with any of these teams, let me know and I’m happy to facilitate an introduction if appropriate. If you’re a company or fund in private markets, feel free to reach out to share a job description you’d like to be listed here to highlight for the Alt Goes Mainstream community.
The latest on Alt Goes Mainstream
Recent episodes and blog posts on Alt Goes Mainstream:
🎥 Watch Lawrence Calcano, Chairman & CEO at iCapital, and I take the pulse of private markets on the third episode of our monthly show, the Monthly Alts Pulse. Watch here.
🎙 Hear investing legends John Burbank and Ken Wallace of Nimble Partners provide a masterclass on investing with a macro lens from John’s background as a leading macro hedge fund manager at Passport Capital and on micro VC from Ken’s background backing some of the top emerging VCs at Industry Ventures. Listen here.
🎙 Hear $40B AUM Cresset Co-Founder & Co-Chairman Avy Stein and Director of Private Capital Jordan Stein live from the Allocate Beyond Summit discuss how private markets are changing wealth management. Listen here.
🎙 Hear Alto CEO Eric Satz discuss how anyone can invest in alternatives through their IRA. Listen here.
📝 Read how 73 Strings CEO & Co-Founder Yann Magnan and team are leveraging AI to build a modern and holistic monitoring and valuation platform for private markets in The AGM Q&A. Read here.
🎙 Hear $18B AUM Savant Wealth’s award-winning CIO Phil Huber talk about how LPs can build a strategy for investing in private markets. Listen here.
🎙 Hear Avlok Kohli, AngelList’s CEO, talk about how they are building the company of companies that is powering private markets. Listen here.
🎙 Hear Seyonne Kang, Partner and member of the private equity team at $134B AUM StepStone, discuss how the VC industry is dealing with today’s venture market. Listen here.
🎙 Hear Chris Ailman, the CIO of $307B CalSTRS, discuss how he manages a portfolio with ~40% exposure to private markets. Listen here.
🎙 Hear Robert Picard, Head of Alternatives at $117B AUM Hightower, approaches alternative investments. Listen here.
Thank you for reading. If you like the Alts Weekly, please share it with your friends, colleagues, and anyone interested in private markets.
If you have any suggestions, would like me to feature an article, research, or would like to recommend a guest or topic for the Alt Goes Mainstream podcast, reach out! I’d love to include it in my next post or on a future podcast.
Join over 2,100 thought leaders from top private markets firms like Blackstone, Goldman Sachs, Apollo, Fidelity, iCapital, Franklin Templeton, and more.