Like a good wine, the best vintages in private markets often come from challenging environments. The best wines aren’t always born from perfect conditions; rather, the best vintages often come from difficult environments, where the vines must work to source water and nutrients. The legendary Napa Valley Cabernet Sauvignon thrives in a dry, hot and sunny climate that ultimately produces a big, bold flavor. Some of their best vintages have come during periods of droughts.
There are two essential determinants of a great wine:
Terroir is mother nature’s influence on grape growing, including climate, soil and natural surroundings.
Vintage is the human element of facilitating the growth and harvesting of the grapes, which includes pruning, irrigation, cultivation, soil treatments, pest management and harvesting process.
Similarly, private market results vary by vintage years, and data suggest that certain strategies perform best in challenging environments.1 The analysis by CAIS, a group dedicated to democratizing advisors’ access to alternative investments, showed that venture capital, buyout and real estate experienced “golden vintages” in recessionary periods. It is not yet clear when or if we’ll have a recession in 2023— but it has certainly been a challenging market environment, and with dislocation comes opportunity.
The last decade has been incredibly strong for private markets, marked by increased demand, high-flying valuations, and annual fundraising topping US $1.2 trillion the past several years. Despite the economic headwinds of 2022, private markets remained relatively resilient throughout the year, with record amounts of dry powder on the sidelines. The failure of Silicon Valley Bank earlier this year put even more pressure on private market valuations, and credit conditions have tightened considerably.
In our view, the disruption of 2022 and early 2023 should create an environment where seasoned private market managers can effectively deploy capital. Valuations have been coming down, exits have slowed precipitously, and there is a scarcity of lending. Much like we see with wine vintages, the best investment opportunities can be produced in challenging periods where declining equity markets, rising interest rates and economic uncertainty prevail.
Private market managers who can effectively prune, cultivate and harvest their portfolios should be rewarded with a resilient vintage. We believe in the long-term merits of private markets and think that 2023 may represent a compelling investment opportunity and a strong vintage year.
WHAT ARE THE RISKS?
All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline.
Investing in private companies involves a number of significant risks, including that they: may have limited financial resources and may be unable to meet their obligations under their debt securities, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of realizing any guarantees that may have obtained in connection with the investment; have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and changing market conditions, as well as general economic downturns; are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on the portfolio company and, in turn, on the investment; generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position.
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1. Source: CAIS. “When Might ‘Golden Vintages’ Appear in Private Markets?” January 24, 2023.