The Paper Trail: Mind the Gap

The Paper Trail has arrived a few days early this month! Enjoying some time off with the family this week and wanted to be as distraction-free as possible as we savor these final bits of summer.

Having just crossed the ten year wedding anniversary milestone a few weeks ago, we wanted to take the kiddos up to where the "big day" happened a decade ago - Traverse City, MI. I may be biased, but Northern Michigan remains America's best kept secret...

Have a great Labor Day weekend and please enjoy August's research roundup, featuring:

• Vintage year diversification in private equity
• "Double discounts" in international value stocks
• Market forces driving direct lending expansion 
• The U.S. Treasury maturity wall
• Megatrends fueling private infrastructure demand
• Private credit secondaries
• Getting off zero in crypto
• The two-tiered market in the CRE office sector
• Exceptionalism, or lack thereof, in U.S. stocks
• Venture-backed unicorns and the full growth-opportunity set
• Capital market assumption (CMA) best practices
• Historical outperformance of small buyouts
• Continuation vehicle misconceptions
• Intangible assets and corporate cash management
• The predictive value of the CAPE ratio

Why is vintage year diversification so important for private equity investors?

"The second challenge with skipping vintages centers around portfolio construction. Due to the unpredictable timing of capital calls and distributions, building and maintaining an allocation to private markets is far more complex than managing public assets. The irregular nature of these cash flows turns commitment planning into a multi-period optimization challenge in which skipping vintages or being too conservative risks under-allocation and missed return potential, while being too aggressive can introduce liquidity risks."

Mind the Gap: The Strategic Risk of Skipping a Vintage in Private Equity (Commonfund)

Are developed international markets the place to be for value investors?

"Despite this improving fundamental backdrop and rising investor confidence, international value firms continue to be priced at a “double discount.” Value firms continue to trade near historic discounts relative to growth stocks, and international markets continue to trade at wide discounts relative to the United States."

Resurgent International Value (Verdad)

Does broader public market volatility make private credit more attractive to borrowers?

"Our overall expectation is that the private vs. public mix will ebb and flow with market conditions, with private credit continuing to steadily gain market share across cycles, as it has done consistently following the Global Financial Crisis. We believe the key drivers of borrower interest in private credit include the relative certainty of execution and terms, the ability to provide a customized lending solution, generally faster execution, enhanced confidentiality, and a partnership-oriented relationship."

Market Volatility: Another Factor Driving Private Credit’s Expansion (HPS)

Should investors worry about the U.S. Treasury maturity wall?

"The maturity profile has notable implications for both fiscal policy and monetary policy transmission. The $5.8 trillion in Treasury bills that must be refinanced annually makes the federal government’s borrowing costs highly sensitive to short-term interest rate movements, effectively linking fiscal expenses directly to Federal Reserve policy decisions. As interest rates rise, the Treasury faces immediate pressure on borrowing costs for bill rollovers, while the medium-term concentration means that roughly $15 trillion in notes will reprice over the coming decade. This structure amplifies the fiscal impact of monetary policy tightening and creates a feedback loop where higher rates increase deficit spending, potentially requiring even more debt issuance."

Treasury Market Creates a Balancing Act (Marquette Associates)

What is fueling the demand for private infrastructure?

"Megatrends driving strong investment demand, coupled with a comparative shortage of traditional infrastructure funding—often from government sources—have created ongoing opportunities for private capital to play a pivotal role in infrastructure development. Allocators assess these investments not only for their alignment with macroeconomic tailwinds but also for the unique attributes of the asset class that distinguish it and result in low correlations to other asset classes."

Constructing the Future: Building Resilient Portfolios With Infrastructure (Neuberger Berman)

What's behind the growing demand for private credit secondaries?

"Investors needing liquidity may turn to the private credit secondary market and find that credit secondaries offer lower bid-ask spreads than in private equity or in real estate, where the terminal value of long-duration assets is much harder to assess. That is because, if properly vetted, the underlying credit provides a predictable, steady stream of income. For a seller with illiquid assets, this is immediately appealing and helps explain the deepening of the market for private credit secondaries."

The Next Frontier in Private Credit Secondaries (Antares Capital)

Is there a "right" amount to allocate to crypto?

"Just as governments brought crypto into the mainstream through careful policy calibration, institutional investors are evaluating frameworks for crypto technologies to be standard in portfolios. That has just begun, and the first step is always the same—to get off zero."

It’s time for investors to Get Off Zero (Coinbase Asset Management)

Are there better days ahead for the real estate office sector?

"From an investment perspective, this two-tier market suggests caution for anything but the best-located, high-quality offices . Valuations for Class B/C buildings have fallen dramatically and may not recover absent a change in use. By contrast, Class A offices could stabilize sooner and retain more value long term. The pandemic did not eliminate the office, but it shrank overall demand, which appears to have concentrated in higher quality spaces. If this trend continues, it is well-advised to distinguish between assets that are truly competitive in this new era versus those that might become stranded liabilities."

Lease, leave, or lose: navigating structural shifts in the real estate office sector (Meketa)

Are U.S. stocks still exceptional?

"Investors today do not seem to recognize that the fundamental growth of the vast majority of American companies over the last five to ten years has been mediocre. The magnificence of the success of the very largest companies in the U.S. stock market has led to an assumption that U.S. companies on average have done well, when in fact they have not. And even if the huge size of the Magnificent Six companies means that they comprise about 32% of every dollar invested in the S&P 500, that still means that 68% is in a group of companies that have, in aggregate, been unimpressive and yet trade at a large premium to stocks in the rest of the world."

American Unexceptionalism (GMO)

Is the trend of companies staying private for longer leaving an innovation gap in investor portfolios?

"If private companies remain prime innovation incubators and if these companies continue to remain private longer and amass substantial valuations, then public-market investors risk missing out on capturing the full growth-opportunity set provided by these companies."

Capturing the Growth of Venture-Backed Companies (MSCI)

Are Capital Market Assumptions (CMAs) useful?

"Most investors’ instinctive outlook duration is 10 years. But it is debatable whether this represents an unconditional base rate, at least considering historic precedent. In the case of equities, your forecast horizon might need to be longer than you think, and applying the same timeframe for all assets could risk oversimplification."

Capital Market Assumptions: Redefined (Man Group)

Have small buyout transactions in private equity consistently outperformed their larger counterparts?

"Small buyouts’ top quartile returns have outperformed those of large buyouts’ top quartile in 13 of 16 vintage years from 2007 – 2022."

The Case for Small Buyouts Part III: Small Buyouts Have Historically Outperformed (RCP Advisors)

Are private equity continuation vehicles misunderstood?

"Therefore, when continuation investments are described as ‘private equity selling to itself’, this is exactly not what these transactions are about. Yes, these deals are typically facilitated through the purchase of a company, or companies, by one private equity-backed fund vehicle from another. But, in practice, continuation investments involve existing owners (fund managers) retaining control of key portfolio companies, while new investors inject additional capital to catalyse growth and existing investors are afforded an option to generate liquidity."

Redefining private equity: How continuation investments are disrupting the buyout market (Schroders Capital)

Why do companies with high intangible investment tend to hold more cash on their balance sheets?

"The basic idea is that intangible assets have limited value as collateral, which caps the debt capacity of those companies reliant on them. Further, many of these companies have good prospects for growth and do not want to be subject to the vagaries of capital markets or economic shocks. As a result, they hold cash to make sure they can run their businesses and fund investment opportunities."

Cash Holdings: Data, Theory, and Alternatives (Counterpoint Global)

Do popular "objective" estimates of equity market expected returns have any predictive ability?

"The main reason for our cautionary tone is that some evidence may make readers too optimistic about the usefulness of these forward-looking estimates. At the same time, the past decade has made many observers far too dismissive of them."

Equity Market Focus: Objective Expected Returns (AQR)