Private equity and venture capital allocations have together benefited private capital investors as they have individually provided outperformance at different points throughout an economic cycle. While both are loosely correlated to public equity performance, venture capital investments have many similarities to growth allocations whereas private equity buyout investments have characteristics similar to value allocations. Buyout returns often depend on lower purchase prices and leverage to generate excess returns, while venture returns tend to be less price sensitive and a reflection of accelerating growth.

The lower correlation between the two assets classes was present for more than a decade, spanning from the 1990’s to the early 2000’s. During this period, an investor would naturally hedge against the heightened volatility in venture by investing in both asset classes to offset this risk. However, since the mid-2000’s these two asset classes have become much more correlated as they both have benefited from a strong, 10-year plus growth-oriented environment coupled with low fixed interest rates.

While correlations have tightened over the past decade, the “growthy” economic backdrop that has fueled this relationship will undoubtedly come to an end. When this occurs, we believe these two asset classes will provide a nice complement over time to investment portfolios in generating a higher overall return with less volatility.

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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.

S&P 500 companies have become “cash rich” as the combination of tax reform and a decade of strong economic growth has resulted in very healthy corporate balance sheets. Accordingly, we have seen the level of cash allocated to corporate stock buybacks steadily increase as corporate leaders continue to have confidence in their companies’ future growth prospects.

During the first half of 2018, the level of S&P 500 planned corporate buybacks has picked up substantially, with announcements exceeding $600 billion through July, which already exceeds the annual levels over the prior decade. Tax reform has significantly improved the profitability of companies, reducing their corporate tax rate from 35% to 21%, with much of that improved cash flow being redeployed into funding business expansions, R&D efforts, acquisitions, and most notably stock buybacks.

However, these numbers are announced buyback approvals and corporations are not always compelled to execute on announced buybacks. If their stock continues higher or growth prospects weaken, they may wait for a more reasonable valuation before executing the buyback. If buybacks are executed prior to growth prospects decelerating and/or a decline of the stock price the capital used on buybacks could prove to have been capital destructive.

It remains unknown how much of these buyback approvals will actually be deployed by S&P 500 companies in today’s high valuation environment. Only time will tell if this corporate buyback activity is well timed or capital destructive.

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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.

Across the private equity industry, valuations have continued to trend higher over the past few years with U.S. buyout valuation multiples reaching 11.8x EV/EBITDA in 2017. These elevated multiples have been supported by an environment of strong economic growth, favorable private market fundamentals, and significant levels of capital available to finance transactions. While buyout multiples may appear elevated relative to their historical averages, EV/EBITDA multiples are still 30% below the average valuation for U.S. small cap companies in the public market. Throughout this growth cycle private valuations have not risen as significantly as they have in the public markets. This valuation discount has provided value-sensitive investors a relative value trade as they seek to rebalance their portfolios.

Going forward, the significant reduction in U.S. corporate taxes that went into effect in 2018 will most directly benefit small U.S. companies as nearly all of their revenues are generated domestically. Throughout the first five months of 2018 we have seen strong growth from both public and private companies, which has led to an acceleration of earnings and cash flow generated by these companies. With less taxes to pay for every dollar of EBITDA, the growth of earnings has made private multiples even more attractive to institutional investors, and will likely drive even greater interest in private equity allocations.

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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.

As a growing number of participants have entered the private markets, the amount of total dry powder has increased. Venture capital funds, however, do not appear to be driving this significant increase in fundraising.  Rather, U.S. venture capital fundraising appears to have remained rational, roughly in-line with the market’s long-term average of $30 billion raised annually, which differs from the more dramatic increases in fundraising within private equity, growth equity, real estate, and private credit.

Dry powder within U.S. venture capital has risen, but remains at a consistent ratio relative to the annual investment level in the industry, currently implying 1.5 years of investment¹ to work through the current levels of dry powder. A key reason for this statistic is the notable level of investments made in the market; in 2017, close to $70 billion was invested, which represents the highest amount since the tech bubble in 2000. Over the last 18 years U.S. venture capital investments have exceeded U.S. fundraising as additional capital has been invested by sovereign wealth funds, corporate venture groups, and family offices.

This increasingly competitive investment environment is forcing managers to work harder to differentiate their capital by providing more strategic value to underlying managers and companies. Market valuations have been high for 4-5 years now, but the early stage venture space hasn’t experienced as much valuation expansion given the inherent business risk. What has changed is a decline in the number of financing rounds, as fewer companies are raising larger amounts of capital and instead are seeking investors who can provide strategic value as many businesses remain private for longer.

We believe it is important to remain disciplined in manager selection as established high-quality managers with broader platforms are positioned to perform well in this environment as they have differentiated capital pursued by many businesses. We believe these managers are more likely to find attractive investment opportunities without overpaying in this competitive environment.

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¹ The ratio of dry powder to annual investment provides an indication of how many years of investment are needed to work through the current level of dry powder. A ratio over 1 implies there is more than a full year’s worth of dry powder based on the most recent annual deployment for the industry. It is important to pay attention to the directional change of this ratio. An increasing ratio is an indicator the investment landscape is becoming more competitive to deploy capital as dry powder is growing faster than investment opportunities.

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.