Active Thinking

At GAM Investments’ latest Active Thinking forum, David Dowsett shares his views on the outlook for markets over the summer while Christian Munafo, Chief Investment Officer at Liberty Street Advisors, discusses the growth of private markets and the reasons why some companies are staying private for longer.

22 June 2022

David Dowsett – Global Head of Investments

• Last week, we saw central banks take action in the US, Switzerland and the UK, leading to a sell-off in risky assets, particularly across developed markets (DM). Central banks have now acknowledged that they are behind the curve but we face an environment of extreme volatility throughout the summer. Any previous hopes of a temporary pause or reduction in volatility over the summer have now been dashed. Every US data release, particularly CPI data, will be closely watched given its influence on the Federal Reserve (Fed’s) interest rate policy, including on the terminal point for interest rates. In our view, this will lead to market volatility, particularly as the Fed itself is reactive to data and not in control of a medium-term plan at present.


• There are also several upcoming important geopolitical meetings, including the G7 and NATO before the end of June. Further, Biden will travel to Saudi Arabia in the second week of July which will be an important signal for the oil price. We expect markets to remain exceptionally nervous during this period.


• From an interest rate pricing perspective, in the forward curve and in the EUR / USD curve, we believe we are getting closer to a sensible expected end point. The Fed’s terminal point for interest rates is priced close to 4% now, which in our view seems realistic. We have seen dramatic capitulation across the credit space over the past week or so; ETF outflows from high yield and investment grade were higher than we have seen at any other period during the past decade. This capitulation is perhaps more evident in credit than equities at present, but we nonetheless see this as good news given such price action is necessary before we can begin to look forward.


• We are beginning to see some outperformance of emerging markets (EM) assets. In Asia, we have seen significant outperformance over the last month across the board compared to DM. EM entered the sell-off earlier than other asset classes and it may be that this is a signal that they will be the leaders as they emerge. While DMs are furiously trying to deflate and reign in on the excess that occurred from a monetary standpoint during Covid, China is trying to inflate, reactivate growth and increase liquidity.


• Crypto continues to make news headlines, but we still see it as a localised bubble. While there may be some implications for specific stocks, despite creating nervousness within global markets, we do not see it as a systemic risk at this point.

Christian Munafo – Liberty Street Advisors

• Over the past couple of decades in the US, the number of publicly listed companies has halved. This means that the opportunity set as an investor in US equities has also halved. During the 1990s, or even the 1980s, the average venture backed company typically went public within four years of its inception, with an average markets cap of around USD 0.5 billion. Today, the same types of companies are staying private for on average 12 years, or in some cases 15 and 20 years, and they are growing into much larger market cap companies in the interim. Companies such as Microsoft, Oracle, Amazon and Google went public much earlier in the development of their businesses than companies tend to do today. This means late-stage venture-backed and growth-orientated companies are evolving and transforming themselves into much larger operating businesses in the private market.


• This development has been driven by a number of factors. One of the reasons companies are staying private for longer is to avoid regulatory challenges. Becoming a public company can be burdensome and expensive and so if companies can avoid that burden, they tend to elect to stay private for longer. Secondly, those companies staying private for longer tend to be later stage high-growth technology and innovation companies. These companies are growing at between 50% and 200% per year and, considering their disruptive and innovative nature, they do not necessarily want to be held accountable to quarterly earnings. When businesses are trying to disrupt an industry or sector and are focusing on expansion, being accountable to quarterly earnings estimates can be restrictive. For that reason, we see a lot of companies opting to remain private for longer until they have matured and optimised various aspects of their business models, after which they can focus on hitting quarterly earnings. The last and most important reason companies are staying private for longer is the amount of capital in private markets, which has skyrocketed. Last year, more than USD 300 billion was committed to the venture asset class, of which USD 230 billion was earmarked just for these later stage companies. We have seen well over USD 1 trillion of capital being allocated to these companies over the last decade alone.


• There is a substantial amount of output generation happening outside of the public market. If you are a public market investor who likes growth, technology and innovation, the data shows that if an investor waits to access these types of companies on the public market, they may be leaving significant alpha generation on the table. Firstly, two-thirds of these companies never go public but are acquired instead, meaning the opportunity set for investors waiting for a company to go public is reduced. Meanwhile, for those which do go public, we believe investors can miss out on substantial alpha generation. Looking at the approximately 600 technology companies that went public over the last decade and comparing how an investor would have performed in just the last private capital raising round to an investor who waited to access the companies in a public market, the alpha generation is not comparable. The data tell a compelling story, in our view: that it is quite prudent to think about providing some exposure earlier than one may have done in the past and accessing private markets.


• In uncertain market environments such as the one we are currently in, we are able to benefit from macro dislocations and negotiate interesting entry points, meaning we are able to buy securities at a notable discount. It is a compelling cycle for capital deployment, in our view, allowing us to secure attractive entry points. Private markets are complementary to a traditional public portfolio, and may offer uncorrelated sources of returns.


• In the last couple of years, both good and bad companies benefited from the rising tide. However, in markets like this, we expect to see a bifurcation and it will become clear which companies have staying power. The companies that are best of breed, that have differentiated products, strong customer bases, good margins, that are either profitable or have a path to profitability will most likely be able to continue to raise at larger valuations, although it may take longer. Other companies, that can avoid doing so, may avoid pricing altogether. They will likely say that they have grown 50% since their last valuation but markets are down dramatically so they may instead choose to do an extension of their last round and worry about the next round in 12-24 months from now. Good companies can justify these narratives, but lower quality companies cannot. These lower quality companies may have down rounds or be acquired cheaply or they will go away. The unfortunate reality is that there has been a lot of easy money raised and invested over the past years. So, from our perspective, valuation is very important through the lens of quality and bifurcation and we believe best in class companies will perform.