Key Takeaways
- • StepStone partner and portfolio manager Michael Elio and Fidelity institutional portfolio manager Ian Johnson attribute endowment underperformance in 2023 largely to outsized venture capital exposure, which continued to drag on returns amid a valuation reset in private assets.
- • Buyout valuations bottomed in Q3 2022 and have posted steady positive returns through 2023 and into 2024, according to Elio.
- • Global secondary market transactions have averaged $117 billion per year since 2021, versus $10 billion in 2009, $42 billion in 2014 and $88 billion in 2019.
- • Elio cites a backlog of private equity exits and a need for sponsors to deliver DPI, with GPs turning to secondaries and continuation vehicles, and sees an early uptick in distributions in Q4 2023.
- • Elio warns that leverage-driven secondary strategies carry risk if interest rates rise or asset values decline, and says the best secondary performance comes from manager quality, portfolio company performance and purchase discounts to fair value.
Summary
In a Q&A on private markets for endowments and foundations, StepStone partner and portfolio manager Michael Elio and Fidelity institutional portfolio manager Ian Johnson discussed the 2023 NACUBO-Commonfund Study of Endowments, which found that the largest endowments, despite significant private asset allocations, posted some of the lowest returns among peers in 2023. Elio attributed this to a continued valuation reset in private assets, particularly in venture capital, where many endowments held outsized exposure. He argued that outperformance in private equity depends on manager selection and deal selection, and said buyout-focused investors fared better, with buyout valuations bottoming in Q3 2022 and recovering steadily through 2023 and into 2024.
On dry powder, Elio acknowledged record global private equity dry powder alongside low investment activity, but said it is modest as a share of fund NAV and concentrated among larger funds. He identified opportunities in small and midsized funds with assets between $7 billion and $10 billion, where dry powder has grown less. Venture capital, by contrast, has seen significant declines in fundraising, which he expects to continue into 2024. On valuations, Elio said private equity sponsors have historically exited at or above prior marks, around 10% of the time, and that recent exits have landed closer to reported NAV, which he views as fair value. He cited declines in EBITDA valuations, with medium, large and global segments correcting an estimated 1.0-1.5 times, and noted that deal flow has shifted toward defensive sectors such as healthcare while cyclical industrials and consumer deals have declined.
On exits, Elio described very challenging distribution activity following the slowdown in M&A and IPO activity since 2022, driven by credit market instability, seller-buyer price gaps and a closed IPO market. He said the resulting exit backlog cannot be avoided much longer, pushing sponsors toward secondaries and continuation vehicles, and he was cautiously optimistic that a recovering leveraged loan market and returning direct lenders would lift distributions in 2024. On secondaries, Elio said global volume has averaged $117 billion annually since 2021, with normal-market trading of roughly 3%-5% of LP interests or 1%-3% of global NAV, against a $11 trillion private equity capital base as of 2023. He emphasized the growing role of GPs in directing secondary transactions and the importance of relationships and information access, while warning that widespread leverage-driven strategies may carry risk if rates rise or asset values fall. He concluded that the best-performing secondary investments are driven by manager quality, portfolio company performance and purchase discounts to fair value.
On dry powder, Elio acknowledged record global private equity dry powder alongside low investment activity, but said it is modest as a share of fund NAV and concentrated among larger funds. He identified opportunities in small and midsized funds with assets between $7 billion and $10 billion, where dry powder has grown less. Venture capital, by contrast, has seen significant declines in fundraising, which he expects to continue into 2024. On valuations, Elio said private equity sponsors have historically exited at or above prior marks, around 10% of the time, and that recent exits have landed closer to reported NAV, which he views as fair value. He cited declines in EBITDA valuations, with medium, large and global segments correcting an estimated 1.0-1.5 times, and noted that deal flow has shifted toward defensive sectors such as healthcare while cyclical industrials and consumer deals have declined.
On exits, Elio described very challenging distribution activity following the slowdown in M&A and IPO activity since 2022, driven by credit market instability, seller-buyer price gaps and a closed IPO market. He said the resulting exit backlog cannot be avoided much longer, pushing sponsors toward secondaries and continuation vehicles, and he was cautiously optimistic that a recovering leveraged loan market and returning direct lenders would lift distributions in 2024. On secondaries, Elio said global volume has averaged $117 billion annually since 2021, with normal-market trading of roughly 3%-5% of LP interests or 1%-3% of global NAV, against a $11 trillion private equity capital base as of 2023. He emphasized the growing role of GPs in directing secondary transactions and the importance of relationships and information access, while warning that widespread leverage-driven strategies may carry risk if rates rise or asset values fall. He concluded that the best-performing secondary investments are driven by manager quality, portfolio company performance and purchase discounts to fair value.
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