by Doug Manor, Managing Director, Neuberger Berman
Today’s CIO Weekly Perspectives comes from guest contributor Doug Manor.
The current price for every listed security in the world, as well as every index of listed securities, is available live from the stock exchange. Second by second, you can know exactly how your public markets portfolio is performing, in both absolute and relative terms.
But if you invest in private markets, you typically receive estimated valuations only once a quarter, and only for your own holdings. Especially at times like these, it can feel like you’re flying blind.
At Neuberger Berman, we are trying to improve the visibility.
We manage more than $100bn in private market assets and, from our unique vantage point in the ecosystem, we see valuation information for more than 400 active private equity funds. Each quarter, we analyze the valuation changes in “real time” as soon as updated marks are received.
We believe this provides a good snapshot of the industry’s performance; and since Q1 2020, we’ve shared our initial conclusions each quarter with a summary presentation. You can watch our Q4 2022 summary of the data here. Our review of the Q1 2023 data—marking the full 12 months since public equity markets peaked and began their decline—will follow in the coming days. Here’s a preview of what we’re seeing…
Resiliency Among Buyout Funds
Approximately three quarters of the buyout funds in our sample rose in value over the first quarter.
Small and mid-cap buyout funds, the largest asset class in the sample, were up 2.7% on average in Q1 2023, in their reported currency. Buyout funds as a whole—including traditional buyout, value buyout/turnaround, and growth buyout/growth equity strategies—were up more than 2% on average, both in U.S. dollars and reported currency.
Over the 12 months to the end of the first quarter, the average buyout fund was up just over 1%. During the same period, the S&P 500 total return index was down nearly 8%, while the Russell 2000 and NASDAQ were down more than 11% and 13%, respectively—despite the notable bounce in public markets since mid-October.
With relatively small changes in value for five consecutive quarters, at this point in the market cycle, buyout funds have enjoyed a much less bumpy ride than public equity markets.
Since the quarterly performance of any single fund can be driven by multiple factors, were the results skewed by a small number of managers with outsized positive returns? Not based on our sample of funds.
In fact, the dispersion of buyout fund returns was relatively tight each quarter over the past year. For example, 56% of the buyout funds had an increase in value of 0 – 5% in the first quarter, while only 6% of funds increased by more than 10% and only 5% of funds decreased by more than 5%. The 25th to 75th percentile ranged from flat to +4.5% in Q1 2023.
Across asset classes and geographies, the buyout funds in our sample experienced similarly tight dispersion. Analyzing the buyout funds by vintage year, we witnessed slightly higher dispersion—and generally weaker performance—among older funds with fewer remaining assets, but relatively strong performance across younger funds that are maturing or still in the harvesting phase.
The picture is less rosy when we turn to venture capital funds, where the valuations of high-growth companies, especially in technology sectors, were especially impacted by higher rates and declining multiples.
On average, the venture funds in our sample were up nearly 2% in the first quarter, but this was buoyed by the positive performance of funds that still hold the public stock of companies that listed in recent years. The median venture fund decreased in value by 0.2% in Q1 2023, on the heels of four consecutive negative quarters in 2022.
Prior to the market downturn, the venture funds in our sample experienced incredibly strong performance, with average annual increases in value of 37% in 2020 and 47% in 2021, far outpacing other public and private asset classes during that two-year period.
But over the last 12 months, the average venture fund in our sample was down 12%. Interestingly, that is very close to the 13.3% decline in the NASDAQ total return index over the same period. But whereas the NASDAQ ended the calendar year 2022 down 33%, the average venture fund in our sample was down only half as much at -17%.
How did private equity funds, and especially buyout funds, hold up so well during the recent turmoil and volatility in the public markets?
In the second half of 2020 and throughout 2021, buyout funds significantly outperformed the public markets, not simply due to rising asset prices, but due to the strength of underlying operating performance and record levels of distributions, driven by successful exits and liquidity events at valuations that were often well above the most recent quarterly marks.
In past recessionary cycles, peak-to-trough declines in buyout fund valuations have been about half that of public equities, generally with a lag and a shorter recovery time. Even so, thus far in this cycle, over the past five quarters, the buyout funds in our sample have been even more resilient than history might have suggested.
We highlight what we view as three key reasons for the recent outperformance.
First, private equity valuations are based on quarterly estimates with multiple valuation methodologies, using not just comparable public companies for reference, but also comparable transactions and discounted cash flow models. These estimates therefore tend to be more consistent and move up and down more gradually than public market valuations, especially during periods of market volatility such as what we’ve seen since the COVID-19 pandemic.
Second, private equity firms are generally both strategic and opportunistic in when and how they monetize assets. Therefore, even though realizations and liquidity events slowed over the past year, the transactions that did occur were often at attractive valuations that exceeded the most recent quarterly estimates, delivering a further boost to performance.
Finally, and most importantly in today’s market, private equity firms manage their portfolio companies very actively. They tend to have significant operating resources at their disposal, and they can use their position of control or influence to respond quickly to the market environment. In recent years, this was paramount as portfolio companies faced supply chain disruption, geopolitical unrest, inflationary pressure, and higher interest rates. Away from the scrutiny of public markets, buyout firms continued to invest behind growth initiatives, make operational improvements, and pursue pricing strategies and accretive add-on acquisitions to maintain margins and grow cash flows. This active management allowed operating and financial performance to hold up relatively well for most private equity-backed companies, even in the face of economic volatility and declining public market multiples.
Like most asset classes, private equity went through a challenging year in 2022. At this stage, it appears that buyout funds performed well through the worst of the cycle, once again demonstrating the potential structural advantages of private ownership, including the ability to be proactive and maintain a long-term view away from the glare and volatility of the public markets.
You can watch our Q4 2022 Preliminary Valuation Summary & Analysis Video here. Look out for our Q1 2023 video in the coming days.
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