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Private Shares – Christian Munafo

Christian Munafo of Liberty Street Advisors notes an improvement in market conditions for investors in late-stage private companies; many of these companies are similar to what public market investors used to seek in small to mid-cap growth stocks. He also stresses that many of them are not just high growth, they are also at or approaching profitability.

What were the major recent events and impacts on your asset class?

I would say, aside from the recent and what we would say are very extremely disturbing developments from a geopolitical perspective, there really weren't any developments that we're aware of that could have a material impact on our asset class and strategy during the quarter. Obviously, the global macroeconomic environment remains challenging, as does the climate here in the US, which is the core geographic focus for our strategy. And, you know, the Fed policy of keeping rates higher for longer is certainly having both direct and indirect ripple effects, we think through most asset classes. However, the benefit to strategies like ours, which focus on investing in late stage, high performing, high growth private innovation companies, is that we're able to negotiate better and better terms because we're taking advantage of these various market and liquidity driven dislocations.

So for us, these times are actually quite attractive for capital deployment, which we have continued doing. But you need to be incredibly selective. And while, you know, late stage venture capital and growth oriented companies in the private markets are not immune, obviously, to various macroeconomic and geopolitical events, and we continue to believe that the private market is bifurcated. Our portfolio and the types of companies we focus on have continued to demonstrate their resilience, which we're happy to see.

We've also started to see some indications, actually, of a positive change in sentiment during the quarter. And I'm happy to give you examples of these, but it includes things such as the capital raising environment. So we're seeing more investors get active and deploy capital. We're seeing more companies in the private space seek capital. We're seeing an increase in exit activity both through mergers and acquisitions, and also some activity in the public listing market. So while we don't expect the environment to turn on a dime, we actually saw some really positive developments during the quarter that we think are going to bode well for our strategy.

What can your asset class offer in the current environment?

Right. So if you look at companies in the US, which again is the focus of our strategy today, they're generating north of 100 million US dollars in revenue, which is a fairly sizeable benchmark to achieve. More than 70% of these companies today are private. We've seen some studies citing that, that number is closer to 90%, but whether it's seven out of 10 or nine out of 10, the point is that 15 to 20 years ago, many of these companies would have already been public. But for a variety of reasons, both public and private market specific, these companies have just stayed private for longer and grown into a much larger market caps inside the private market. And if you actually look at the characteristics and the operating metrics, many of these companies demonstrate, they're actually similar to what public market investors used to seek in small mid-cap growth stocks. So in a sense, late stage venture and growth, the way we define it becomes a bit of a proxy to small mid-cap growth. And so if investors don't have access to this late stage private innovation, we would argue that they're missing out on a substantial portion of the overall economy today.

I'd also say that by investing in these later stage, high growth, highly differentiated businesses ranging from artificial intelligence and machine learning to cybersecurity, robotics, the space economy, big data and analytics, digital health, and bio platforms for both human health and agriculture. And companies that have strong balance sheets with investors who are willing to support them. We think this asset class provides very attractive risk adjusted returns. And just because companies have not been going public at rapid rates, and we haven't been seeing surges in valuations like we saw during the peak of Covid.

These companies are still able to grow into much larger operating businesses inside the private market while they build into that harvest phase. So investors that are able to access these companies and were patient, can really benefit, we think, from capital appreciation and ultimately the exit in whatever form that exit takes. And just because the private markets are, you know, hard to access, it doesn't mean that investors shouldn't be looking for ways to access them. We think asset managers are continuously looking for ways to democratise access, something that we've obviously been doing for nearly a decade with our business.

And due to the structural illiquidity of private markets, there really is a lot of inefficiency that sophisticated investors can take advantage of to try to get those attractive entry points. And as I said a few moments ago, periods of increased volatility and dislocation make those opportunities to negotiate favourable terms even more achievable. So we wouldn't say it's prudent to time any type of a strategy, let alone ours. But we do believe that various metrics and macroeconomic volatility driven dislocations are creating a very attractive capital deployment opportunity into our asset class.

What is your outlook in the near and medium term?

Yes so we would measure the outlook based on a few different parameters. You know, in terms of the valuations of these types of companies. You know, we continue to believe that the market is bifurcated. So you have best in class, high performing, very differentiated businesses that are in a very different position compared to companies that are less differentiated. Small balance sheets, right, not exhibiting premium operating metrics. Those are the companies that we're seeing face increased pressure. So from a valuation standpoint, it hasn't been easy the last 18 months. But we are definitely seeing signs of improvement. So we're seeing more rounds getting priced. We're seeing better valuation terms being negotiated which is a good sign. So I'd say from a valuation standpoint we're definitely seeing an improvement in that market condition.

In terms of exit activity, which I think is another measurement of how the overall asset class is performing. We have seen a pickup in both M&A. From corporates, private equity oriented buyouts as well as public market oriented events. Now the M&A environment has been challenging not just because of the macro but also because of regulatory pressure. But we are seeing things improved there and the terms are actually getting quite attractive. That's a good development. We have a long way to go, but that's exciting.

From a public market’s perspective, we've seen some of the first venture backed IPOs list in the last four to six weeks, when it was quite slow in the prior 15 to 18 months, and most of those IPOs were oversubscribed by five to 10 times. Now, we would argue that some of those companies that went out may not be the best that the private market has to offer. But overall, the signs of public market investors wanting to get behind new companies, we think overall is a good indication. And you have one of the largest pre-IPO backlogs of venture backed companies that we've seen in more than two decades. And a lot of these companies are not just high growth. They're also at or approaching profitability. So you have a nice balance between growth and profitability.

That said again, you know, while we are seeing signs of sentiment shifting, we remain keenly aware of the challenges that the macroeconomic and geopolitical environment present. But historically, as we've said before, these types of periods tend to provide very unique access and the ability to negotiate favourable terms that may generate outperformance in subsequent years. So while times like this may not seem to be the right times to investing, historically, the data tells us these are actually typically the best times for capital deployment. And the subsequent years you'll typically see outperformance.

Is there one chart you’re currently monitoring closely?

Yes. So as we've said before, as you noted, there's a lot of different data that we have to follow as private market investors. So it's not just looking at your typical public market economic and market oriented metrics and statistics. It's also private market data. And the private market data is, quite frankly, not easy to access. So our ability to have decades of experience in this ecosystems and have confidentiality agreements in place to access a lot of that information is actually quite helpful. But it's typically, you know, the normal stuff, right? From a public market perspective, you know, you're looking at, you know, interest rates, which we know what's been happening there GDP, unemployment, what's happening right with the listed exchanges. what's happening with valuation metrics of these assets, etcetera. And then that kind of transcends to some extent into the private market. So we're looking at what are these businesses doing, how are their operating metrics evolving, what's happening with their margin profiles, if they're not yet profitable, what's happening with burn rates. So a lot of that's important. So there's a lot of different information that we have to monitor. But there's no single chart unfortunately that we follow. Again it's a combination of different data points.

Important disclosures and information
The information contained herein is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained herein may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information contained herein. Past performance is not an indicator of current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice or an invitation to invest in any GAM product or strategy. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented. The securities included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers.

No guarantee or representation is made that investment objectives will be achieved. The value of investments may go down as well as up. Past results are not necessarily indicative of future results. Investors could lose some or all of their investments.

References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in indices which do not reflect the deduction of the investment manager’s fees or other trading expenses. Such indices are provided for illustrative purposes only. Indices are unmanaged and do not incur management fees, transaction costs or other expenses associated with an investment strategy. Therefore, comparisons to indices have limitations. There can be no assurance that a portfolio will match or outperform any particular index or benchmark.

This presentation contains forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of GAM or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.

Christian Munafo

Chief Investment Officer, Liberty Street Advisors, Inc

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