Category: Chart of the Week

2021 Smashes VC Records as Late-Stage Deals Reshape the Market

U.S. venture capital deployment in 2021 smashed the previous record set in 2020, as $329.8 billion of funds were infused (+98% from 2020) into over 15,500 deals (+27% from 2020). While this tremendous volume of investment was deployed across the market, late-stage deals in particular raised over $100 million in capital in the last year. In fact, within the U.S. venture capital market, the substantial amount of late-stage venture deployment alone eclipsed the previous overall deployment record by 15%, as $190.8 billion of investments were deployed across 4,704 late-stage deals during 2021.

The growth trajectory of the late-stage venture capital market has been steadily climbing over the past decade as part of a broader evolution of the space, as private market companies have become larger and more durable due to capital availability, increased transparency, and minimal reporting requirements. That being said, the market may have now reached a size at which investors could begin to view early-stage venture capital and late-stage growth equity as distinct asset classes given the different investment considerations associated with each (e.g., duration, risk, returns, etc.) and separate the two within portfolios. Indeed, as late-stage deals become larger in size they become increasingly different investments, as many growth companies that have previously been supported by early-stage venture investors evolve into more established businesses with substantial revenues, proven product-market fits, much shorter duration (five years or fewer), lower loss potential, and valuations that are more aligned with public market peers.

As the venture capital market continues to expand due to new participants and existing investors increasing their allocations to the space, it is worth considering allocation mixes within portfolios with an eye toward having specific and dedicated early- and late-stage venture capital deployment targets.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Office Space in Need of a Booster

As the Omicron variant continues to spread like wildfire across the globe, companies once again find themselves modifying plans for a return to in-person work. Although the market for U.S. office space started to show signs of stabilization during the second half of 2021, the new wave of Omicron cases has already started to impede the recovery across most industries. As a result, the office sector could potentially endure the most profound and longest lasting impact from the recent case surge among the four major core property types. Current remote work dynamics and incremental office supply are expected to exert additional upward pressure on vacancy rates, which increased during the third quarter of 2021 to 16.8%. While the emergence of virus variants and the prevalence of unvaccinated individuals may act as catalysts for permanent changes within the office sector, many companies are expected to opt for flexible work schedules in 2022 rather than leasing additional real estate. With businesses contemplating further vaccination requirements, as well as continued travel restrictions and virtual interactions, there now exists a widening gap between occupied and underutilized office space. To that point, net absorption rates, which serve to quantify the difference between leases and vacancies, have fallen by roughly 120 million square feet during the pandemic, representing the largest drop since the 2001 Technology Bubble.

Going forward, corporations and employees alike may be forced to navigate through a unique work environment on a permanent basis. While hybrid and remote working approaches will likely serve as headwinds for the demand for office space in the aggregate, institutional investors may be well-positioned to achieve portfolio alpha with long-term exposures to high-quality tenants, Class A properties, office conversions, and distressed low-occupancy buildings. As a firm, Marquette will remain focused on working with our clients to target markets with a compelling mix of talent, demographics, and tenants.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Credit Spreads Snap Back from Initial Omicron Surge

Given the positive news on the weakness of the Omicron variant and its susceptibility to at least some of the COVID-19 vaccines, credit spreads have generally retraced their widening since the first Omicron case in South Africa was reported to the World Health Organization on November 24th, 2021. Our chart this week compares high-yield spreads against two averages using the Bloomberg High Yield index. The lower dotted line is the average spread for the year-to-date period, with current spreads sitting just above of this figure. The higher dotted line is the since-inception average spread (excluding the extreme periods of 2008 and 2009), with today’s spreads still generally extremely tight compared to this long-term average despite the recent Omicron scare. While we assess only U.S. high yield corporate spreads, these are generally representative for investment grade bonds, bank loans, and emerging markets debt as well.

Omicron has quickly spread to at least 57 countries around the world thus far, but spreads tightened across the board last week as President Biden chose to institute stricter COVID-19 testing requirements for travelers entering the U.S. from abroad instead of implementing more lockdowns and broad mask mandates. Additionally, Moderna and Pfizer have been mobilizing to update their vaccines against the Omicron variant. However, the tail end of last week brought with it some widening pressure as Europe tightened its COVID-19 restrictions and the Consumer Price Index saw a 6.8% increase for the month of November on a year-over-year basis, topping the previous month’s 6.2%. This figure raised some concern that the Federal Reserve may accelerate its tapering and rate hike schedule.

Last week, the fully vaccinated rate remained at 60% for the U.S. and rose one point to 45% for the world. With still a long runway to go before herd immunity levels of 80% are reached, and since issuers remain risk-averse as evidenced by benign fundamentals ranging from generally low leverage to use of loan and bond issuance proceeds directed towards refinancings rather than LBOs, we may expect spreads to potentially tighten further. It is worth noting that this tightening may not be without potential dislocations along the way. As of this writing, spreads are very near all-time tights. Marquette will continue to monitor fixed income valuations, fundamentals, and technicals as we progress through the recovery from the pandemic.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Don’t Forget About Those Old 401(k) Accounts!

According to a recent study conducted by Capitalize, $1.35 trillion worth of assets were held in forgotten 401(k) accounts as of May 31st, 2021. This figure is based on estimates of 24.3 million retirement accounts with an average balance of $55,400 per account. Based on this study, it is evident that millions of participants are missing out on additional retirement savings each year their old accounts are left behind with previous employer plans, since holding multiple accounts often leads to investors incurring higher fees. To that point, Capitalize estimates that an individual could experience up to $700,000 in foregone retirement savings as a result of forgotten 401(k) accounts. As 2021 draws to a close, plans sponsors should look to begin the new year by helping employees consolidate retirement accounts, which could lead to cost savings and the accumulation of plan assets, by utilizing the following tactics:

  • Confirm participant data, including email and mailing addresses, is up to date to ensure communications will be received
  • Collaborate with the relationship manager of your retirement plan recordkeeper to develop a targeted participant communication strategy (email, hard copy mail, or onsite visits) that highlights the benefits of consolidating retirement accounts from previous employers
  • Ensure communications clearly explain the process for rolling over outside retirement assets
    · Paperwork required to effectuate rollovers can be confusing to many participants, however, the majority of recordkeepers employ support teams available to assist individuals with transfers
    · The phone numbers and email addresses of these support teams should be clearly identified in communications to participants
  • To increase the chances of success when it comes to participant rollovers, communication campaigns should be continued throughout the entire year

Finally, technological developments and the reporting capabilities of retirement plan recordkeepers will allow plan sponsors to measure the effectiveness of these campaigns. By the end of 2022, sponsors should review results related to the number of rollovers completed, the amount of assets gained, and the extent to which employees were actively engaged with the topic during the year. This may help plans delineate future goals and better understand the most effective ways to communicate to participants.

If this is of interest to your plan, please contact your Marquette consultant for additional information.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

 

‘Tis the Season for Consumer Spending?

The COVID-19 pandemic resulted in significant changes to, among a plethora of other things, consumer behavior in the United States. As a result of the virus outbreak in early 2020, the personal savings rate of domestic consumers saw a dramatic increase to a record high of 26.0% in the second quarter of last year. This propensity for conservativism during times of economic hardship can clearly be seen in our chart this week. Direct relief payments made to individuals as part of the government’s massive stimulus program were among the primary contributors to increased personal savings rates, as consumers saw limited opportunities to spend while in lockdown. As time went on, many individuals used excess savings to pay down debt and invest in equity markets, which helped fuel historic levels of retail trading activity. Online retail sales also increased a few months into the pandemic in large part due to pent-up demand, as indicated by the 10.0% quarter-over-quarter change in personal consumption during the third quarter of 2020.

With the holiday season upon us, many investors are curious about the state of the American consumer in light of the challenges posed by the last two years. On one hand, consumer balance sheets remain relatively strong. At the end of the third quarter of 2021, the personal savings rate in the United States was roughly 9.6%, well above the figure recorded at the end of 2019 of 7.4%. This likely means that individuals have more cash at their disposal than in previous years. At the same time, there are several headwinds facing consumers that may persist into the new year. Higher costs due to inflationary pressures and supply chain difficulties have already impacted a significant number of Americans and may cause a drop in consumer confidence if these issues are persistent in nature. The Omicron variant and other strains of the COVID-19 virus may also lead to renewed calls for economic shutdowns, which could leave consumers with fewer spending options. Finally, it is important to note that while the personal savings rate rose overall for consumers during the first several months of the pandemic, increased rates of savings were disproportionately attributed to higher-income individuals and households. This could mean that a large subset of the population is ill-equipped to deal with rising costs and, as a result, unable to spend at levels consistent with history. Ultimately, only time will tell how the American consumer will respond to ongoing uncertainty and whether governments and policymakers will see a need to provide additional economic relief. In light of the dynamics at play and the headwinds currently facing consumers, investors should remain realistic and pragmatic about spending levels heading into the final month of 2021.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Bulls on Parade: What’s Driving the 2021 Digital Asset Rally?

The first bitcoin futures ETF — the ProShares Bitcoin Strategy ETF — was approved on October 15th, making it easier for investors to access the most well-known cryptocurrency. Not surprisingly, Bitcoin’s network value (the market capitalization) surged on the announcement, reaching $1.13T (equating to $61,571 per coin). However, this was not the first time Bitcoin’s capitalization crossed $1T: as the orange line in the chart shows, Bitcoin’s total value has crossed this threshold several times since 2020, with significant volatility along the way.

Certainly, the ProShares ETF approval has provided more access to investors, and the October run-up can at least be partially attributed to this new channel. However, there also appears to be an evolving demand dynamic in terms of investor type, which could create broader acceptance of cryptocurrency as an asset class in the coming years. We can examine this trend by looking at the types of transactions on the bitcoin network to see what has changed over the last five years.

Illustrated in blue and on the left axis is bitcoin’s daily exchange-to-network flow ratio: this measures bitcoin transfers on open exchanges (both inflows and outflows) as a percent of total network transfers. The total network is a classic ledger of accounts, the blockchain technology which serves as the foundation for all cryptocurrencies; transfers are debits and credits to and from accounts. Transfers are classified as either open exchange (retail investors), or over the counter (i.e., wholesale, OTC — more akin to institutional investors). As the ratios in blue approximate open exchange flows, the remaining network transfers approximate OTC flows. Overlaying exchange flows and network value propounds the degree to which exchanges drive or do not drive asset appreciation. To that point, the data illustrated above suggests three points:

  • Historically, retail participants via open exchanges drove Bitcoin demand. Daily exchange-to-network flows surged from mid-2017 through mid-2020, averaging ~35.2%, with a high of 99.4%.
  • Around August 2020, the drivers of demand shifted. Daily exchange-to-network flows decreased and have sustained five-year lows, averaging ~15.4% in 2021, with a low of 0.8%.
  • OTC transfers correspond with the 2021 rally, averaging ~84.6% of network transfers. Although it is not definitive, this implies institutional wholesale transfers are the dominant driver of Bitcoin’s value appreciation through 2021.

Taking this analysis a step further, it appears that more institutional money is driving demand for bitcoin. In the past, the infancy of the asset class coupled with the radical volatility of returns was enough to frighten most institutional investors off. If the trend suggested by this chart continues, however, bitcoin and other cryptocurrencies may become a more common holding across institutional portfolios.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

China: Regulators, Mount Up!

Over the last year, the Chinese government has enacted a series of new regulations targeting several domestic industries including finance, health care, and real estate. In general, the policies that have garnered the most attention are those directed at Chinese technology companies and range from restrictions on the use of advertising algorithms targeting consumers to limitations on the amount of time children are permitted to spend gaming online. As displayed in this week’s chart, these new regulations, the majority of which have been codified in the last few months, have shaken equity investors and led to a significant drop in the MSCI China Index. Specifically, the benchmark lost roughly 18.2% in the third quarter of this year alone as investors scrambled to react to the new regulatory environment in China and its ramifications.

Recent efforts of Chinese government authorities mark a sea change in the country’s social and economic goals and the ways in which those goals are pursued. For decades, China was largely comfortable with encouraging economic development at all costs, however, it seems officials in Beijing have now shifted their focus to pragmatic, quality growth with an emphasis on both prosperity and sustainability ahead of National Party Congress elections in 2022. It is worth mentioning that the developments of the last several months do not constitute a new experience for Chinese companies or investors. China’s government has a history of stepping in after periods of unchecked economic growth, with the targeting of the gaming industry in 2018 serving as a recent example. That said, the significant volume of policy changes that have been enacted in the last year has caught many investors by surprise, which has led to the drawdown in Chinese equity indices described earlier.

While this type of volatility can be difficult to stomach for most market participants, it can also allow investors the chance to purchase securities at more attractive valuations. To that point, many portfolio managers with a focus on Asian markets have expressed an interest in increasing their exposure to Chinese equities over the coming months given the dislocations that have potentially arisen as a result of the recent pullback, though most still expect market fluctuations to continue in the near term. Investors with exposure to Chinese markets should remain disciplined in their approach and cognizant of both the risks and potential opportunities stemming from the current situation.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

The More the Merrier?

A driving force for most investors seeking to add a private equity allocation to their portfolios is the strong performance that the asset class has consistently generated over time. Since 2009, the total number of global private equity investors has more than tripled, growing to nearly 10,000 global investors at the end of 2020.  The asset class has historically experienced a 5%-15% increase in the number of new investors on an annual basis, however the growth of new private equity investors has been 10%-15% in recent years. We believe these growth figures will remain elevated due to continued strong demand, which is largely driven by return targets, strong equity markets, and portfolios that have become larger and better able to accept illiquid private market allocations.

As more investors enter into the private equity space, it will likely become more difficult to access top performing managers due to fund size capacity constraints and the deeply established relationships that formed between early investors and these managers as they grew their platforms. Investors who are unable to gain exposure to the funds of established managers will need to seek out emerging managers for allocations.  While these emerging managers have historically provided a higher median return due to strong incentive alignments and smaller fund sizes, they have come with a much wider range of performance outcomes.  New and existing investors are likely to require guidance as difficult choices will need to be made when it comes to either constructing a new private equity program or refining an established program. To that point, difficult selections must be made as many managers are both returning to the market more quickly than they have in the past and raising larger funds with capital deployment outside their historical focus.

All of this being said, investors should not be deterred from exploring the value of an allocation to the private equity space given the benefits the asset class provides, including diversification and the potential for strong absolute returns. While the private equity investor universe is mostly comprised of larger, institutional investors like pension plans, endowments, and foundations, high-net-worth individuals and families have increasingly made allocations to private equity investments in recent years. We would encourage clients with sizeable asset levels, the ability to build diversified programs, and appropriate tolerances for the illiquidity associated with these types of investments to consider adding an allocation to private equity within their portfolios in a prudent and thoughtful manner.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Can Equities Provide a Hedge Against Inflation?

Inflation has been at the forefront of the minds of many investors in recent months as higher price levels have resulted from economic reopenings and supply chain dislocations across the globe. For instance, the consumer price index — which measures the cost of a basket of goods purchased for consumption by urban households in the United States — rose 0.4% during the month of September, coming in slightly above expectations and translating to a 5.4% jump on a year-over-year basis. Notably, the yearly spike in the CPI is the most significant in over a decade. While the debate on whether current inflation levels are transitory in nature or pose a longer-term threat to the economic health of the world is of great importance and will clearly continue for some time, the question of how investors can mitigate risks stemming from price level increases through the use of different asset classes is also worth exploring.

Real assets, including commodities and real estate, are known to be robust inflation hedges due to the fact that input costs, along with property values and rental income streams, tend to rise in tandem with overall price levels. The case for equities as a guard against higher inflation can be argued by pointing out that revenues and earnings of companies with inelastic demand for their goods and services may also rise along with inflation, due to the fact that firms with strong customer bases are able to pass on price increases to end consumers with relative ease. Generally speaking, this argument has held true in recent decades, as U.S. equity indices have tended to appreciate during inflationary periods going back to the late 1970s. Specifically, and as displayed in this week’s chart, equities have demonstrated hedge-like performance characteristics during periods of moderate inflation (CPI increases of 1–10%) and have largely generated positive real returns during those time frames. It is important to note that recent performance trends are likely aberrational, as equity indices have bounced back quite strongly after pandemic-induced troughs that occurred around the same time as the beginning of the current inflationary period. During times of significant inflation (CPI increases of 10% and above), equity performance has been more mixed, with returns of various style indices usually positive (though often coming in below the prevailing inflation rate). Regardless of whether or not the current inflationary regime is transient or long-term in nature, the data clearly indicate that equities can play a role in helping to lessen the impact of price level increases on the purchasing power of investment portfolios. Prudence and diversification across the asset class spectrum can also help investors endure elevated inflation levels that may persist into the near future.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Back So Soon?

Over the past decade, U.S. private equity firms have returned to market sooner and sooner. The fundraising environment for these organizations remains attractive due in large part to strong performance and the persistent gap between private and public market valuations. Furthermore, the current robust dealmaking climate, both in terms of platform investments being made and potential add-on activity throughout the period during which portfolio companies are held, means that managers are both investing their funds more quickly and holding additional capital in reserve. These factors have resulted in more frequent fundraises.

This dynamic of accelerated capital deployment introduces incremental risks for private equity investors, including increased vintage year risk with the potential for greater return dispersion throughout an economic cycle. Moreover, more frequent fundraising could put stress on a private equity firm’s team, both with respect to the investment professionals leading deals and the operational resources executing value creation plans. Finally, more frequent fundraising, if not accompanied by shorter hold periods, will require private equity firms to return to the market more regularly with less realized performance, as potential gains stemming from recently deployed capital will be largely unrealized.

The trend of private equity firms deploying capital more quickly and returning to market sooner puts pressure on limited partners to continuously think strategically about portfolio construction. Thoughtful, consistent investment pacing that is supported by a robust go-forward pipeline of compelling fund opportunities will help to mitigate many of the aforementioned risks. Additionally, a deliberate approach will allow limited partners to prioritize opportunities in which they have the most conviction, gain access to those funds, and capture the outsized return potential of private equity investments.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.