Sapient Capital Alternatives Market Update

BY Peter Teneriello / Apr 10 2023 / Article

“Taste Matters”

Peter Teneriello, Director

There’s a concept in filmmaking called auteur theory: that moviegoers should recognize the director’s touch onscreen. In fact, the best movies should be inseparable from their directors—no one else could have executed on those visions.

This extends beyond film: music, paintings, even food. Why do we love what we love? The best showcases their artist’s vision. Lower quality art may provide a sugar high, but we’re drawn to the brilliant and unique. Investing is no different, but few invest like artists, with creativity and conviction.

How do we find such investors? Taste. Honed by experience, letting us separate what doesn’t matter from what actually does: finding investing styles differentiated from everything else, and ultimately vindicated by their performance. Styles that wouldn’t exist without their artist.

Finding artists now doesn’t just require experience—as our observations should demonstrate, this market environment requires taste to succeed.

Fundraising is at its most challenging since the aftermath of the Global Financial Crisis 

The song has remained the same across close to 100 meetings and countless conversations we’ve had within our global network of fund managers in 2023: this fundraising environment is extremely challenging, especially for smaller and newer funds. Institutional investors are facing pressure to reduce their alternative investment exposure, in turn reducing the amount of dry powder available for both new commitments and re-ups. The charts below bear this out—global alternatives fundraising was already falling, and we wouldn’t be surprised to see 2023 fall well behind 2022’s pace.

Our outlook – Fund managers that don’t need to fundraise are avoiding it at all costs, stretching their dry powder as far as they can. This may lead to 1) many managers delaying their fundraises from 2023 to 2024, but also 2) opportunities to invest with access-constrained managers who typically work with endowments/pensions/etc. rather than RIAs. Fund managers have to be flexible with their fundraising timelines now.

Sentiment is very negative among venture capital investors 

Even before SVB’s collapse and UBS’ acquisition of Credit Suisse, venture capital transaction volumes were already sinking back towards pre-COVID levels. Those broader financial system events have negatively affected sentiment among venture investors—there may not be “blood in the streets” yet, but the feeling during SVB’s collapse was intensely negative, even more so than during March 2020. That’s because more so than private equity, venture in particular was extremely impacted by the FDIC shutting down SVB, given the many banking/lending relationships SVB held with VC firms and portfolio companies. 

Our outlook – Directly related to the SVB collapse, SVB did have a number of balance sheet assets that will likely be of interest to the broader investment world. At a higher level though, this may create a lending gap for venture-backed companies and present opportunities for investors with opportunistic mandates, some of whom have already been active.

New deals and exits continue to slow down

The current environment remains challenging for buyers and sellers across the alternative asset class, given the uncertainty surrounding the rise in interest rates and the subsequent impact to lenders. It’s too early to tell for 2023 but as the charts below show, private equity exits fell off a cliff in 2022 to the lowest levels since 2013, and new private equity deals have also fallen significantly.

Our outlook – Holding periods should continue extending even further out for private assets. Longer holding periods, combined with slowing deal volume as investors conserve dry powder, should further compound the industry’s slowing fundraising pace. That said, these factors may give investors like ourselves more leverage in fundraising conversations.

The dispersion between the best and worst managers has persisted

Over the past 10 years, a very large dispersion between the top and bottom quartile managers has continued to persist in the alternative asset classes (as opposed to other more-accessible ones). What’s driving this dispersion, even as capital inflows increased over this time period? Active manager selection in the alternative asset classes done well is resource-intensive, and not every investor can dedicate the resources necessary for consistently finding the best managers.

Our outlook – As capital inflows grow and more managers target RIAs in fundraising, returns may compress in the alternative asset classes. However, we’re avoiding where the return dispersion may compress the most: less-differentiated, lower-performing mega-cap funds. Why wouldn’t they compress as much elsewhere? Many investors want the return potential that alternative investments can provide, but not everyone can build the machine to unlock that potential—the structural and behavioral barriers to investing in smaller funds are real (but surmountable).

In closing (and with more brevity than the preceding paragraphs), this is what we’re seeing in the alternative asset classes:

  • Sentiment is very negative among venture capital investors 
  • Fundraising is at its most challenging since the aftermath of the Global Financial Crisis
  • New deals and exits continue to slow down
  • The dispersion between the best and worst managers has persisted

Though these observations and the news headlines may seem negative, we don’t consider this environment un-investable. There’s always a trade, and if a trade intersects with the fund managers who meet our bar, an investment opportunity will bloom. The artists are already on offense though, and investors with dry powder will join them on the playing field shortly—it’s our job to find them now.

Sources:

Risk Disclosure 

Alternative investments are designed only for sophisticated investors who are able to bear the risk of the loss of their entire investment.  An investment in an alternative investment should be viewed as illiquid and interests in alternative investment are generally not readily marketable and are generally not transferable.  Investors should be prepared to bear the financial risks of an investment in an alternative investment for an indefinite period of time.  An investment in an alternative investment is not intended to be a complete investment program, but rather is intended for investment as part of a diversified investment portfolio.  Typically interests in an alternative investment are not registered under the US Securities Act of 1933, as amended (“the Securities Act”), and the fund is not registered as an investment company under the US Investment Company Act of 1940, as amended (the “Investment Company Act”), and as such, investors will not be afforded the protections of those laws and regulations.  A prospective investor should carefully review all offering materials associated with an alternative investment, including the risk factors, and should consult his or her own legal counsel and/or financial advisor prior to considering an investment in an alternative investment. 

General Disclosure 

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor. 
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. 
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed.  There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. 
Sapient Capital is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Sapient Capital and its representatives are properly licensed or exempt from licensure. 
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