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Chart of the Month: March 2024

March 18, 2024

Law of Averages: Comparing 3 Decades of Commitments Among Buyout, Venture Capital, and Credit Funds

In private markets, we regularly analyze three main facets of our Cobalt market dataset— performance, fundraising, and cash flows—to gain insight into the fund commitments that limited partners (LPs) have made across their portfolios. Today we’re analyzing those commitments to see what we can learn about optimal portfolio construction, just as we’ve done in the past.

This chart highlights the average commitment sizes from 1990 through 2023 among three of the main alternative investment styles: buyout, venture capital, and credit.

Key Takeaways

That chart illustrates some well-known points in the alternatives investment space.

  • Venture capital set the baseline of lowest average commitment size at $20 million over the last 30 years.
  • There’s also a general trend of commitments rising over time, in line with the growth of private equity during the 2000s and 2010s.
  • The largest exception in the chart is from 2009 – 2011 during the financial crisis, when average commitments dropped rapidly (down nearly 50% from 2008).
  • Altogether, the trends imply that average LP investment levels generally chart with the health of the market over time.

Surprisingly, the largest LP commitment sizes by investment type swapped, with credit having the larger average for nearly a decade between 2007 and 2017. That’s despite buyout firms having raised over double the amount in fund size compared to performance in the same timeframe. In other words, there was likely a smaller LP base with a sizable allocation to credit, but that smaller base made larger investments, on average.

Nearing midway through the current decade, we are seeing a clear divergence: Buyouts have grown their average investment size 64%, while credit has lowered investments by 74%.

 

Looking Ahead

Our 2023 data show that credit barely exceeds venture averages. If the pattern persists, it would be the first time since 1993 that they come in as the lowest of the three strategies.

While high interest rates are the largest macro factors in the private credit market, our investor data also shows a changing trend in portfolio creation that may be factoring into the dropping commitment average. From 2000 – 2009, LPs with credit investments averaged 1.7 investments per year. In the new decade (for years with complete data 2020 – 2022), the average has jumped to 2.6.

The increase may be indicating that LPs are committing a similar dollar amount from their portfolio—but spreading it across more individual funds, and therefore dropping the average check size to today’s lower levels.

It’s unlikely buyouts can maintain the last few years’ pace of growth. The previous high-growth period lasted three years (2010 – 2012), and if future years continue to look like that, we should anticipate the average buyout commitment to normalize.

One aspect that may cause this time to be different, though, is the continued expansion of buyout fund sizes compared to other strategies. Post-2015 buyouts greater than $2.5 billion have become much more commonplace, with over 30 being raised each year. That offers LPs opportunities to invest more in the funds, potentially propping up the inflated averages so far in the 2020s.

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.
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Cobalt Expands Data Regions: A Step Forward in Addressing Data Residency Concerns while Ensuring Security, Privacy, and Control

March 8, 2024

Cobalt Expands Data Regions: A Step Forward in Addressing Data Residency Concerns while Ensuring Security, Privacy, and Control

At Cobalt, we understand that security and privacy are a top concern for our clients. With the sheer volume of data private equity and venture capital firms handle daily, it’s only fitting that safeguarding this information is of paramount concern. Cobalt is committed to protecting your data as if it were our own, ensuring that strong security and privacy measures are always in place. 

Data residency is a growing concern we have noted amongst the firms we work with, especially those located outside of the United States. With data residency regulations varying from one country to another, firms are rightfully worried about where their sensitive investment data ends up being stored and processed. Certain jurisdictions even mandate data storage within their borders, adding complexity to the decision-making process when selecting software vendors. 

To address these concerns, Cobalt has launched new data centers in various regions across the globe. The goal is to provide our clients with a choice of where their data is stored and processed. Our new data centers will help mitigate data residency concerns, and more importantly, ensure that our clients can effortlessly comply with their respective country’s data regulations and their firm’s data governance policies.  

With Cobalt, your data is not just secure; it’s where you want it to be.  

Get in touch with the Cobalt team to learn more about our multi-region data residency support:

 

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Chart of the Month: February 2024

February 20, 2024

Buy the Rumor, Buy the News: Evaluating the Unshakable Interest in Real Estate

While investing in sanguine times has been an oft-held motto of contrarianism, what happens when even bad times are good times? Following up on last month’s analysis, we continue our analysis of the real estate market.

Long viewed as one of the safest markets, real estate has also seen dramatic increases in interest from both retail and commercial investors over the past decade. As such, we’re looking at real estate investor contribution and distribution values compared to the overall market change for a public real estate index, the DJ Global Select Real Estate Securities Index (RESI).

Key Takeaways

While our data on pre-2010 cash flows is sparser, readers who remember the events of 2008 might recoil at the idea of an invulnerable real estate market. As shown above, while the cash flows do not tell much, the index is very clear that real estate contributions were quite tepid coming out of the great financial crisis given shaken investor confidence.

This tepidity quickly waned, however, and the market was progressively built up with more investor interest and steady contributions through 2020.

Now in 2024, we see the same curiosity play out as it did in 2008, but for different reasons. The index dived in reaction to the pandemic, and the cash flows remained relatively fixed. This cannot be blamed on low data volume, but instead a perseverance of investor interest throughout the economic shock.

The confidence appears to have paid off, with distributions peaking in late 2021 alongside a peak in new contributions. This reaffirmed a desire to collect profits and reinvest the earnings in the real estate space—even amidst the real estate market lag of 2022 and 2023.

 

Looking Ahead

A second fallacy in the invulnerability argument is the bubble. One need only glance at a chart of US home prices to get a little concerned about the sustainability of this trend. The US is trying to ramp up new construction to stem the housing shortfall, and the open question of return to office looms over the commercial sector.

As we look forward into the rest of this decade, we expect some shakeups in real estate performance. It could be driven by either or both sector’s challenges and perceived overvaluation. However, whether the bubble bursts or local and national efforts to address supply and demand reign in the values, there will always be intrinsic value in the real estate sector.

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.
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Chart of the Month: January 2024

January 26, 2024

Perfectly Hedged? Questioning the Tether Between Private Credit and the Federal Funds Rate 

Akin to Steve Eisman’s critique of how a firm can lose money in every interest rate environment, our analysis this month poses the question: How has the private credit market endeavored to make money in nearly every interest rate environment?   

To investigate this, we pulled the private credit market return over the past few decades from Cobalt’s Market Data to see how these funds responded to changes in the federal rate, and to examine how they may have pivoted to remain profitable. 

Key Takeaways

First, we can identify points of alignment between the two charts. The trough and peak in North American private credit returns between Q2 2008 and Q3 2009 clearly align with the 2008 recession and accompanying sharp drop in the Federal Funds Rate. We surmise that existing funds were gutted by portfolio company defaults, while new funds were used to acquire the distressed assets that became available.    

Looking ahead, we see a smaller version of this event in 2020 that coincides with the COVID-19 pandemic drawdown. The lag times in both charts, however, are not consistent, indicating that the interest rate is not a strong predictor (or even a lagging indicator) of the private credit market performance.  

By comparison, the private credit market is relatively agnostic to the Federal Funds Rate during the other periods. There appears to be no meaningful effect from the dot-com bubble and the subsequent rise in interest rates—or any strong effects from the rock-bottom rates of the “everything rally” of the 2010s.  

However, on closer inspection, we can see a predictable increase in private credit volatility about three years after a recession, coupled with slight downward performance as the Funds Rate increases. The volatility was likely due to distressed purchases during downturns that began torealize their value or failure. The performance likely emerged from higher borrowing costs that cut into a private firm’s ability to increase financing to their portfolio.

Looking Ahead

Moving past the 2020 drawdown, we can apply our findings and predict a period of slightly higher credit volatility in the coming quarters. Additionally, as the Federal Reserve appears to be pausing its rapidly ascending rate hikes, we are left at a potential crossroads for the private markets. 

 On one hand, the pause could prolong economic health and sustain a high funds rate for longer, potentially eating into private credit returns. On the other hand, if a more recessionary event is close, then there may be ample cheap opportunities for distressed investors to buy. 

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.
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Chart of the Month: December 2023

December 12, 2023

The (Bar)Bell Curve: Looking at the Dispersion of PME Alpha by Private Market Funds

In past charts, we’ve discussed our PME (public market equivalent) engine and how it can be used to analyze a fund or group of private market funds against the public markets. The chart below encompasses our entire population of funds with cash flows and examines the most common outcomes of performance. Using the Cobalt PME methodology to compare our Market Data Funds against the MSCI ACWI, we generate a PME Alpha metric for funds with cash flows, and the dispersion of this alpha is reflected in the chart below.

Key Takeaways

Perhaps unsurprisingly, the largest group of funds are those with alpha over 14%, with over a quarter of funds reaching that threshold. A bit more surprising may be that second most common range is alpha less than -7%, with just over one-eighth of funds falling here. Between these two extremes we see a more typical distribution between -7% and 14% performance.

This creates a unique distribution where the most likely outcome is extreme over-or-under performance, with the next most likely result falling closer to 0%. The ranges reflecting slight overperformance and slight underperformance are the least common, signifying a market where private market investors are looking for big swings, and living with the big misses they may create.

Extending to include all funds with negative alpha, we see that 28% of funds have underperformed in comparison to the public markets. This likely skews towards newer funds, which often take a few quarters or years to start returning distributions and outperforming public equities. Still, this lines up with the idea that alternatives offer the chance to have outsize returns versus other markets, but the investments do come with more downside risk.

Looking Ahead

As this sample looks back on 20 years of data, it should be enough of a track record to give us a solid idea that the dispersion pattern moving forward will hold. There may be some slight variances, especially as funds raised in the volatile times of the pandemic begin to make their first distributions over the next few years but overall, we still expect the most common outcomes for funds to be higher outperformance or lower underperformance compared to the public markets.

For more information on PME and how Cobalt leverages it, download our white paper: Measuring Performance in Private Equity: The PME Cheat Sheet.

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.
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Chart of the Month: November 2023

November 14, 2023

Playing the Long Game: Comparing VC & Buyouts Across Different Time Horizons

Within private markets, there’s often a focus on core metrics such as internal rates of return, multiples, and public market equivalents. However, Cobalt’s dataset collects cash flow information that enables users to derive metrics such as the time-weighted rate of return (TWRR) for a group of funds.

To highlight this metric, the chart below illustrates TWRR for the North American, Global, and Western Europe markets to compare the regions’ buyout and venture capital (VC) funds across different time horizons.

Key Takeaways

At first glance when comparing the two charts, the different patterns the VC and buyout funds take across each time horizon stand out most. The VC curve shows a slow decrease year-over-year, while buyout returns increase from the 10-year horizon, peaking at the 3-year horizon with a large increase. This spike can most likely be attributed to the timing of the chart, with a 3-year horizon starting in March 2020 (the bottom of the markets during the pandemic).

Another time period that jumps out is the negative venture capital returns at the 1-year horizon. We’ve covered many of the macro factors (including our analysis of first quarter 2023), but increasing interest rates and bank scares at the beginning of 2023 (SVB in particular) created a tough environment for VC on the 1-year timeframe.

A closer comparison of the two charts shows an emerging trend: VC generated higher performance on the 4-, 5-, and 10-year horizons, while Buyouts outperformed over the past 3 years. While VC had the stronger run throughout the relatively stable 2010s, it seems Buyouts are better suited for the uncertain financial climate and volatility that has defined the beginning of the 2020s.

Looking Ahead

Given this current trend, you might expect buyout funds to be a stronger investment in coming quarters. While each investment style has a higher rate of return for 3 horizons, venture capital’s outperformance lasted over 6 years. If this trend holds, Buyout investments still have a few more years remaining as the top performer. However, with so many unknowns and looming issues in the macro environment, it would not be surprising to see a quicker reversal of fortune.

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.
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Chart of the Month: October 2023

October 12, 2023

More BRICS in the Wall: Analyzing the Effect of Currency Choice on Fund Performance

In light of the recent BRICS summit and the group’s goal of de-dollarization, we explored the effects of currency choice on global private market investing via two representative portfolios:

  • USD funds investing outside of the US 
  • Non-USD funds investing across the globe

We then compared each to the S&P 500 to see how they perform relative to the American public market equivalent (PME). 

Key Takeaways

Looking at the charts, the two portfolios display largely similar characteristics overall. Both progressions peaked in 2000 and cratered shortly after, reflecting the crash following the dotcom bubble. Then, we see positive progression again through the mid2000s until a crash during the financial crisis of 2007-2008. Finally, investors received a calm tailwind to finish the 2010s with a safe and consistent outperformance of the S&P 500 at around 10%. 

 

The non-USD portfolio generated a much higher average level of returns than the USD sample for the bulk of the 2000s, and then leveled to the USD group around the Great Recession. But what caused non-USD funds to outperform their dollar-denominated counterparts throughout the mid 2000s?  

The performance of the Euro may be one factor. Euro-denominated funds make up a large portion of the non-USD portfolio, and that currency exhibited strengthening compared to the USD over that period. Another explanation may be European market outperformance during that period. Indices, including the FTSE 350, expanded close to 2x from trough to peak progression in the mid-2000s, while the S&P 500 only expanded around 1.5x during the same period.  

Looking Ahead

It will be important to keep in mind U.K.’s continued struggles with inflation when observing the next trends in Western Europe. Most other major economies have reduced or muted the effects of inflation at this point, while the U.K. may still be mired in a macro climate that’s less friendly to alternative returns. 

With a more volatile environment, it will be interesting to see if the unexpected observations in the venture capital and buyout lower quartile returns revert back to the average benchmark moving forward. 

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.
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Chart of the Month: September 2023

September 14, 2023

Down and to the Right: Assessing Western Europe Alternatives by Investment Style

After a recent portfolio monitoring client win in Spain, we decided to review Western Europe for this month’s analysis on alternative fund performance. In the chart below, the Q4 benchmark for each investment style illustrates how a Limited Partner (LP) may assess their portfolio weightings in the region 

Key Takeaways

Unsurprisingly, venture capital and buyout funds have the highest first quartile returns. However, the roles are reversed on the downside: Venture capital remains completely above a 0% return, while buyout funds have more risk of not returning an investment. This highlights that ingrained trends often appear in the aggregate, but focusing in on a specific region may expose deviations from the norm.  

The largest investment styles in the alternative fund space (venture and buyout) offer the highest returns, but they are joined by growth equity and real estate, two other styles that have the highest upper fences of the benchmark. It’s important to note that co-investments are just behind real estate in this regard, having a higher first quartile floor. 

The investment styles with lower fence bounds (credit, infrastructure, fund-of-funds) do offer the benefit of tighter overall benchmarks, meaning an LP may have a better idea of their overall return when investing in these styles. Fund-of-funds exemplifies this best, with only a 6% difference between the upper and lower-fence of the benchmark. 

Looking Ahead

It will be important to keep in mind U.K.’s continued struggles with inflation when observing the next trends in Western Europe. Most other major economies have reduced or muted the effects of inflation at this point, while the U.K. may still be mired in a macro climate that’s less friendly to alternative returns. 

With a more volatile environment, it will be interesting to see if the unexpected observations in the venture capital and buyout lower quartile returns revert back to the average benchmark moving forward. 

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.
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Chart of the Month: August 2023

August 11, 2023

Alternate Current: Studying the Early Divergence in Energy Market NAV vs. Dry Powder 1995-2022 

The energy market is consistently prone to violent price swings in reaction to global news. As a result, it’s a difficult style to invest in safely and steadily, despite its ever-growing demand. As follow-up to our June analysis, we‘re looking at more investment styles that deviate from overall trends. As shown in the chart below, Energy varies from other private market trends by splitting the tether between NAV (net asset value) and dry powder at an earlier date and higher ratemore than any other style. 

Key Takeaways

Let’s look at the difference in dates. The main market divergences between NAV and dry powder were in 2009 and 2020. These were significant investment inflection points, and in both cases, NAV began to rise beyond dry powder levels as investors spent down the latter to invest into these distressed markets. We can see this reflected in the chart above as well; NAV briefly exceeds dry powder levels from 2010 to 2015 and then accelerated in 2020. 

However, between 2015 and 2020, there is a massive rise in NAVs as investors spent down dry powder amid a globally declining energy investment period and historic drops in oil prices. One explanation for the rise was the push for renewable energy sources, such as solar, that began to grow in 2016. In addition, cost-saving measures pushed renewable costs closer to and then below parity with fossil fuels. (Take a look at the Energy Infrastructure Funds raised.) Those opportunities may have attracted the remarkable investment. And as the demand for new or divested energy is constant, so too is the appetite for additional investment in this space. The environment at the time could have signaled investors to go all in and spend down their dry powder. 

Looking Ahead

As we alluded, even with the steady march of technological progress, the energy space is subject to strong macro fluctuations. Economic downturns or another pandemic could easily sideline energy demand and pricing in the medium term. Despite the risks and the tribulations of 2020, appetite for this investment style has persisted and strengthened. This gives credence to the sustainability of this wave of investmentas long as dry powder reserves remain. 

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.
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How private equity firms can make software implementation a cinch

July 19, 2023

Successful implementation of investment portfolio management software isn’t just some ideal-state dream. It’s a must-have tool for any competitive private capital manager. And with some basic understanding and advance planning, PE and VC teams can avoid common implementation pitfalls and enjoy the efficiencies of modern portfolio management.

As a provider of investment portfolio management software, Cobalt has helped PE and VC teams of every size prepare for and executive successful software implementations. Here’s a sampling of the best practices we’ve learned along the way:

  • Define the business objectives of implementation. What does your company aim to accomplish by adopting new systems? How will workflows improve? What does success look like? Without clear goals, implementation can miss the mark on strategic outcomes.
  • Cement a go-live date and stagger deadlines—and plan for workload surges. A detailed schedule with department-specific expectations will help you meet target dates. Recognize that extra effort will be required to get new systems off the ground—so consider allocating extra manpower during implementation to avoid overworked staff, missed deadlines, or both.
  • Outline your strategy for managing historical data. Existing data will need to be loaded into your new system. Determine which data will be transferred and identify the locations of all data you will need. To ensure nothing gets overlooked, assign responsibility for each element of data to a specific team member.
  • Inspire your team. Humans chafe at change: Some resistance to your implementation objectives is par for the course. Limit opposition by ensuring that all members of your team will truly benefit from investment portfolio management software—and then communicate those benefits. Make sure all parties know how this shift will make their jobs easier.

Approaching software implementation with intentionality and foresight allows private equity and venture capital firms to reap the benefits of investment portfolio management software—from advanced collaboration capabilities and sophisticated analytics to streamlined reporting and personalized dashboards—with minimal discomfort.

To learn more about typical pain points during software implementation and how to avoid them, download our white paper, “The Private Equity Firm’s Guide to Painless Software Implementation.