The Crypto Winter of Discontent: Examining the Value of Venture Capital Tech over the Past Decade 

Cryptocurrency values continue to be hammered in 2022, revealing many crypto-focused hedge funds and exchanges have been built on a foundation of highly leveraged sand.  

Considering the “crypto winter” befalling the industry (and the upcoming seasonal winter in the Northern Hemisphere), we’ll look at the lead-up to the downfall to see how we got here.  As such, we built a portfolio of 185 venture capital funds with a technology focus, using quarterly data as a proxy for interest in crypto investment over the past decade. 

Key Takeaways:

• The most obvious takeaway from this chart is the consistent upward net asset value (NAV) growth from 2012 to 2022. As part of the “everything bubble,” venture tech (and tech as a whole) has been a highly expansive industry of late. The associated rise in asset value reflects this steady growth. In addition, it’s clear that contributions and distributions have also correspondingly risen over this period, further indicating increased interest and payout from these investments. 

• However, we see the monumental rise in NAV since 2020 has more than doubled the total invested value in previous years. Understandably, contributions and distributions would not rise at the same rate as NAV in the case of a rapid rise in consumer demand for the underlying technologies. If this enormous NAV is not quickly captured through distributions, the gains may evaporate for general and limited partners just as easily as they arrived. 

Looking Ahead:

• As consumer confidence in technology and crypto has shifted from skepticism to fervor (and incredible market cap growth) to distrust over the past several years, the chart shows an industry poised for its coming fall. The rise of drawdowns and defaults could create significant impairment for retail and institutional demand. 
• On the other hand, technology continues to underpin economic growth in our modern society. If faith in tech big and small is restored and macro conditions improve, the drawdown could slowly reverse

On the World’s Stage: The Middle East & Growth in the 21st century

The World Cup is set to kick off later this month in Qatar and with it, global attention to the country and region will shift over the next 2 months. Therefore, this month’s chart examines the region from a private markets performance perspective. As a follow-up to the dive into Emerging Markets this past July, we’re doubling-down on MENA (Middle East & Northern Africa) funds and analyzing the growth of the market through both the NAV and distributions of the underlying funds.  

Key Takeaways:

• Total Value in MENA hit an all-time high of $6.8 Billion to start 2022. This high value trend continued every quarter since Q1 2020, much in line with the rest of the economy’s upward trajectory after the initial COVID-19 shutdown in March 2020. In MENA, this was driven mostly on the NAV side, signaling that it was new LP commitments and growing investments that have caused the recent upturn.
   
• The recent rise in NAV also brought the market nearly in-line with distributions for the region ($3.33 B and $3.45 B respectively). This marks the first time since 2018 that both cash flows were in line, as distributions rose steadily throughout the 2010’s. These trends begin to make sense as we look further back into the 2000’s in the region.
   
• From 1999-2007, the Total Value of the region was almost exclusively tied to the NAV of the underlying funds. Only from 2008 onwards do we see significant distributions. This will often be the case for a nascent, emerging market, as the fund lifecycle may take over five years to produce pertinent returns. The steady growth of distributions in the 2010’s then makes sense as a result of a more maturing market bearing more success.

Looking Ahead:

• As mentioned in our last Emerging Markets piece, the structure and opportunity in the Middle East bodes well for continuing the growth trends in the area (Venture Capital specifically). However, as we know the macroeconomic climate has been changing recently, in the short term we shouldn’t expect the vertical line growth seen over the past few quarters. 
• One thing to keep an eye out for will be to see if the recent influx of NAV will bear out another run of substantial distributions in the years to come. 

In for a Penny: Comparing FTSE Performance Against Various Private Market Geographies

Last month, pundits boldly claimed that the United Kingdom is being viewed as an emerging market nation. While this may exaggerate their current economic status, many were perturbed by the UK’s budget plan (released amidst political turnover and energy crises), and reactions simultaneously lowered GBP valuations while raising government bond yields.  Such a combination often indicates supremely low confidence in the government. Thus, we ask: how does this connect to private markets?  This month’s chart uses the FTSE 350 as a proxy for historical public market sentiment of the UK in comparison to Cobalt’s in-house PME calculation to see if any notable comparisons could be drawn across various geographies in the past decade. 

Please note: “Emerging Markets” refers to any private fund that invests in Emerging Markets across the globe, rather than a particular region. 

Key Takeaways:

• In the chart above, ‘Europe – Western’ acts as a proxy for UK Buyout performance.  Unsurprisingly, ‘European Buyout’ offers a premium to public market performance over that period.  Even though the European funds contain more nations and funds than just British ones, it still convincingly shows private market outperformance by that region’s funds. ‘North America’ also delivered similar levels of outperformance. While not all developed regions will deliver identical returns, they will likely deliver outperformance over public markets regardless of which developed region is chosen. 
• Two examples of emerging market funds are presented in ‘Asia – Emerging’ and ‘Latin America’.  In both examples, the reader can once again see consistent outperformance by private markets compared to the FTSE public benchmark.  Despite lacking much of the deal infrastructure enjoyed by developed markets, the opportunity for growth and rapidly increased investment into these regions over the past decade allow for the significant outperformance seen here. 
• Finally, funds that are invested across the emerging market display the weakest overall performance.  Ironically, the FTSE shows the closest return to the private emerging market landscape.  However, this says more about the overall risk/return profile of emerging markets than public market performance and should caution that regional diversity does not inherently improve performance. 

Looking Ahead:

• As the British markets roil forward, European private markets will likely continue to demonstrate outperformance over their public counterparts. Moreover, if British public securities, bonds, and currency conditions continue to worsen, we may see greater investment into private markets across the globe. 
• Even emerging markets may see improvement.  While the British economy may not truly be an emerging market, the decreased demand for its assets and the ever-increasing funding and infrastructure funneling into emerging opportunities may push further outperformance there, even in areas where present outperformance is less significant. 

Dialed In: Examining Capital Calls Across Varying Market Conditions

As the United States just experienced its second straight quarter of negative GDP growth (an unofficial marker of a recession by some measures), we wanted to look at how capital calls have ebbed and flowed through the past two decades of both financial downturns and extended growth. This 20-year period offers multiple examples of both, which give us insight into how contributions are affected across a wide array of market conditions. Using the Cobalt Market Dataset, we examined funds across all geographies and investment styles raised from 2000-2021 and looked at their contribution pacing from 2002-present. Contribution pacing in Cobalt is calculated by taking overall contributions to a fund as a % of its unfunded total. 

Key Takeaways:

• The longest trend we see above is throughout the 2010’s, where capital calls remained relatively steady with a slight upward trendline. This was in line with other markets, as equities and others experienced uninterrupted growth over the decade. A possible explanation for this decade-long uptick may be connected to the smaller drawdowns seen in the stock market, namely in 2011,2015, and 2018. These could be seen as ‘healthy’ corrections, leaving capital call less susceptible to a halt in activity. 
• During the Global Financial Crisis (GFC), an immediate and substantial impact was made on capital calls, with the annual rate dropping to 17% in 2009. The next lowest rate was 30% in 2010, signifying just how steep the impact was in the aftermath of the crisis, as investors tightened the purse strings and remained cautious for multiple quarters at the start of the recovery. 
• However, during the COVID crash in 2020, capital calls remained consistent on a quarterly and annual basis, with nearly identical results to the previous year. In fact, 2021 continued the trend of steady growth in pacing, highlighting that capital calls will react differently in overarching economic downturns depending on the differing market conditions. 
• Interestingly, when looking at capital calls on a quarterly basis, the average pace increases steadily throughout 2021 from one quarter to the next (8.1% in Q1, 8.8% Q2, 10.6% Q3, 13.2% Q4). Since Cobalt Market Data provides a net-level view, we don’t have insight into deal-level data and flow. However, one possible explanation is that deal activity increased as dealmakers look to wrap up outstanding deals before year-end, causing Q4 to be a bit of a small outlier compared to the other quarters. 

Looking Ahead:

• Though there has yet to be a recent fall in contributions pacing, there may be some slowdown expected in the coming quarters as a sustained downtrend has taken hold of the markets. It is possible that the past few quarters of volatility and attrition are more likely to weigh down the activity of capital calls, as opposed to the sudden impact and recovery of COVID in 2020. 
• The impact may be less pronounced as well due to another factor, as the decade-long steadiness of contribution pacing seems more sustainable than the overheated run-up we see in the chart from 2002-2008. . 

From Small Things: North American Venture Capital Compared to the Russell 3000 

Last September, we did a study examining buyouts vs. the Russell 3000 in the context of the economic volatility of 2020. This month, we’re revisiting this idea applied to a different section of the private markets: venture capital. Given that the present economic shakeup may have significant effects on the tech leaders of the 2010s, we thought it prescient to look at how the future innovators have been performing compared to the public markets. Using Cobalt’s in-house PME calculation, we compared the two indexes over the past 20 years to see what factors may inform performance. 

Key Takeaways:

• Our last chart emphasized how buyouts could often take advantage of weaknesses in the public markets. By contrast, we see the unique issues suffered by the venture capital market—the market was heavily impacted by recessionary events, even compared to their public counterparts. While public markets do stall out during recessionary events, there appears to be a sharp decline in venture performance for funds raised around these periods, likely due to a pullback in investments and demand leaving many of these fledgling companies out to hang. 
• In the second half of the chart, we see another trend at work. While the dot-com bubble clearly impaired the venture capital market for a long time, venture quickly rebounded from the global financial crisis and accelerated far quicker than the public markets. While the “everything rally” of the last 10 years raised all ships, venture capital seems to have been especially productive during this time. This is likely due to its positioning allowing for far greater growth than more established markets.

Looking Ahead:

• Having flirted with two recessions in the past three years, there is much speculation on the direction of financial markets. The 2020 recession proved remarkably short-lived, and the present turmoil continues to teeter on the fringes. Venture capital is not at the heart of the drawdown so we can extrapolate that while the venture market may suffer acute setbacks from investor jitters and denominator effects, overall interest will remain strong and could likely bounce back faster than public markets. 
• Given that many of the largest drawdowns in the latest downturn have been in the big tech sector, there may be even greater opportunity for innovative venture-backed companies to rebound and feast on the lost market confidence in the former innovators of Big Tech. 

MENA Reversion: The Roots of Current and Future Trends in Emerging Markets

The recent break in the years-long trend of the “everything rally” across markets means that strong portfolio performance might be harder to come by rather than being a given. This will cause investors to look elsewhere for alpha, whether it be different markets, focuses, or geographies. With that in mind, we examined emerging market datasets within Cobalt Market Data to see which of these markets has been most popular, by both total number of funds as well as fundraising amount.  

Note: Cobalt Market Data does have an Asia-Emerging classification, but this segment has been removed from this analysis due to being an extreme outlier among the markets in both metrics. 

Key Takeaways:

• When these geographies are grouped, the first thing that stands out is that Latin America and MENA (Middle East and Northern Africa) are far outpacing Sub-Saharan Africa and Europe CEE/CIS (Central and Eastern Europe). Latin America (305 funds) and MENA (312) account for 64% of funds raised in the set, with Sub-Saharan Africa (172) and Europe CEE/CIS (180) making up the other 36%. 
• Interestingly, MENA’s fundraising total ($64.5 billion) is closer to the smaller two markets than it is to Latin America ($99.8 billion). Latin America is an area of high fundraising activity at larger total fund sizes, while MENA is also an area of high activity, but at a smaller average ticket. 
• After digging into the numbers, the root of the discrepancy becomes evident: 47.6% of all dollars raised in Latin America are attributed to Buyout funds, while Venture and Growth Equity accounts for 16.3%. Conversely, Buyouts are only 19.6% of the MENA market, compared to the region’s 58.6% in Venture/Growth. The different approaches in each region account for the differing dynamics in fundraising totals. 

Looking Ahead:

• As the MENA market continues to mature, it will be interesting to see if the pattern between the two regions remains consistent or begins to evolve. We believe that the makeup of the MENA markets will remain for two reasons: the sources of capital and economic ambitions of the region.  
• Regarding the capital sources, sovereign wealth funds of the region have been investors in private equity portfolios for some time and more often they are looking to invest domestically, along with their current North American/other developed market commitments. Moreover, the economic ambitions of many countries in the region are focused on hyper-modernization over the ensuing decade. This structure bodes well for venture capital funding, as rapid growth and expansion of companies and services in a growing economy lends itself well to the venture model. 
• Zooming back to include all regions, there has been overall growth in emerging markets. From 2000-2009, 223 funds raised $58.9 billion in these regions. In the following decade, from 2010-2019, 523 funds raised $125.4 billion. If this growth continues, we expect over 1000 funds to raise over $250 billion in the regions by the end of the 2020’s. We would not be surprised in the least as well if we look back in eight years and these numbers have been surpassed. 

Making Sense of Contrary Indicators in the Developed Credit Market

As predictions of contractions in private markets begin to rise, we thought it would be prescient to follow up our April chart and provide a counter examination of the extended credit market to elaborate on the demand trends in that sector over the past decade. To examine demand, we analyzed the market from two angles: by contribution rate and total contributions. This allows us to visualize the absolute demand, granular quarter-to-quarter shifts, and changes in demand independent of overall commitment size.

Chart #1

Chart #2

Key Takeaways:

• In the first chart above, we see notable trends in commitment rates. Between 2013-2014, the overall rate peaks above 75%. This is well above average and indicates that this was a particularly popular time to invest into distressed opportunities, likely taking advantage of the market rebound following the global financial crisis.
• Commitment rates trend down after 2014, reaching a low in 2021. In general, we anticipate long-term contribution rates to be around 40% of total commitment, so to see mean reversion is hardly surprising. The trend overshoots this goal and ends at around 35%, but this will likely be revised upwards to match the long-term average. The likely explanation for this is the lack of distressed opportunities in the 2010’s; once markets had completed their rebound, they continued to deliver into one of the most surprising bull markets in memory. As such, there was little opportunity for distressed investing until 2020, when opportunities were cut short by the remarkable rally.
• How does this fit in with the second chart? We see a strong trend over time of increased investment, which can be explained by macro factors: the early years have suppressed values since we have a smaller sample of vintages. In 2017, total investment begins to increase at a sharper rate. This is partially due to the rising tide effect, as money poured into private equity in all spaces. This also explains the drop in contribution rate. More money was flowing into credit funds out of a demand for alternatives, but there was no increased specific opportunity flow, thus letting the contribution rate return to its natural state.

Looking Ahead:

• As the drawdown of 2022 deepens and markets continue to contract, there may be a considerable number of credit opportunities emerging over the coming years. Because credit is uniquely suited to a distressed approach, it may not share the same patterns of drawdowns that other sectors of the private markets may experience over the next few years. Instead, it may pounce and see high demand (assuming valuations remain depressed).
• We can also anticipate a short-term fall in contribution rates while markets contract, a period which could last until 2023-2024 depending on the severity of the drawdown. However, demand will likely spike again once markets fully rebound as seen in 2013.

Private market investing is a collaborative enterprise. There’s a lot of information sharing among staff within a general partner and with portfolio-company management, limited partners, and a host of outside partners. And since the Covid pandemic forced all industries to scale back our face-to-face interactions, private-market investors have needed more ways to exchange data electronically.

That’s why a recent release to Cobalt’s Portfolio Monitoring software includes sophisticated collaboration and sharing capabilities. Foremost it’s now possible to design a report or dashboard in collaboration with others, so multiple people can work on a draft report simultaneously before it’s published.

And there’s more.

Once completed, reports can be shared in multiple ways: they can be sent directly to someone or put in a folder to which a group of people have access. Users can be designated as viewers or editors. But any change can be rolled back to a previous version. Anyone familiar with Google Drive will feel very comfortable with the approach in Cobalt. 

In addition, we’ve made our software smarter about the roles played by all the investors in a deal. Now data can be displayed from the perspective of your firm, other outside investors, or all investors as a group.

With so many ways to collaborate, it’s time to build reports worth sharing. Cobalt has been working on this, too. We’ve published a white paper outlining the five essential dashboards every private equity manager needs. You’ll see the best ways to organize information about a portfolio company’s financial performance, valuation, marketing, and ESG commitments. There’s even an overview dashboard designed for the Monday morning partners’ meeting.

Download your copy of the white paper here:

The Rolling Stone Gathers Momentum: Resilience and Investor Interest in Eastern European Markets

Eastern Europe has come to the forefront of current events this year with the conflict in Ukraine. Continuing our exploration from last month , we wanted to examine the private equity landscape of the region, given that it is often underexplored compared to the Western European markets. With that in mind, we used the Cobalt Market Data to analyze the total cash flows from 2010-2021 in Central and Eastern Europe.

Key Takeaways:

• At the start of the decade, distributions were few and far between. This could largely have been due to the recession immediately preceding the 2010’s, as distributions across the board were suppressed throughout the market.
• Conversely, contributions were still being made at the start of the decade, and the distributions finally did follow. Starting in 2015 and peaking at the end of 2017, the region accounted for over $3.2 billion in distributions in the middle of the decade.
• These cash flows happened despite the Crimean conflict in 2014, as well as debt crises in the area, and the announcement of the Fed Tapering plan taking place in the same year. This may point to investments, at least in the private markets, proving to be resilient in the area despite surrounding uncertainty.

Looking Ahead:

• Given the current unfolding situation, it would be foolish to say with confidence where the market is headed as things change from day to day. That being said, with Russia Ukraine being some of the of the largest economies in the region, the negative effects on the greater economy may be felt in the private markets.
• After a brief period of lighter investment, the region did see an influx at the end of 2019. Based on the past trend from earlier in the decade, we may see a similar string of distributions 3-5 years later under normal circumstances. Time will tell if these will still be able to happen on schedule in the current climate.

Data, they say, is the new oil. And just like petroleum, raw data needs to be cleaned and refined before it’s a useful fuel. For few is that more true than private equity managers, which must keep track of hundreds of data elements for each of their portfolio companies.

This was the theme of a recent Webinar for fund general partners titled “Value In, Value Out: Business Intelligence Starts with Quality Portfolio Data.” During the event, Hank Boggio, chief commercial officer at Cobalt, offered that “Rather than a necessary evil, portfolio company data is the backbone for reporting and analysis, often driving strategic firm decisions.”

The webinar drew on the experience of Cobalt, a leading provider of portfolio monitoring software, and Alvarez & Marsal, a consulting firm with expertise in private equity performance improvement and analytics.

Here are four of many insights from the event that might surprise general partners (GPs):

Collecting data from portfolio companies saps productivity.

A typical small or midsize private equity manager typically gets financial updates by email from portfolio companies, with an associate copying data to spreadsheets. The data is often copied again from the spreadsheet into reports for partners and updates sent to investors. Taken together, all this is a drain on the firm’s resources. “General partners tell us on a regular basis they want to ensure that the investment team spends less time collecting and re-keying data and more monitoring and managing the companies in their portfolio,” Boggio said.

More data has more problems than most understand.

The ad-hoc process for gathering information too often doesn’t spot errors and inconsistencies in the data provided by companies. All that manual copying, in fact, introduces more. “If you haven’t taken a close look at the state of your data, you may not really understand the problems you have,” said Cole Corbin, the senior director of fund analytics and reporting services at Alvarez & Marsal. “We’ve seen all kinds of issues, from major integrity problems to cases where like-for-like comparisons were not being done right.”

Employee turnover can undermine data.

Another consequence of informal approaches to collecting information is that a lot of critical knowledge about the process is in the minds of a firm’s investing staff. Experienced associates not only know how to transfer information from company reports to your internal spreadsheets, they also can spot anomalies and errors. “In these times of the Great Resignation, we’ve seen GPs look for ways to lessen their reliance on individuals to collect and organize their data,” Corbin said.

Automating data collection improves data accuracy and saves time.

Instead of manually entering information, GPs have a few options to automate data ingestion into a portfolio monitoring software (such as Cobalt). These workflows can be designed with logic that flag errors and other data-quality problems. They can spot internal inconsistencies, e.g., when the revenue line items don’t add up to the total. And they can alert the investment staff if any data element changes unexpectedly from prior periods.

The webinar also explored how portfolio monitoring software can identify risks and opportunities in private equity portfolios. These analytical tools can be very powerful, but only if the data they are based on is reliable. “The basic mechanics of collecting the financial, operating, and performance metrics from each portfolio company is very repetitive and highly prone to error,” Boggio concluded. “As with any data-centric system, ensuring that the information captured for reporting and analytics is critical.”

Watch a replay of the webinar here: