Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Public markets sketchy on private valuations
Venture capital and private equity have produced the most popular source of new IPOs in recent years, but public market investors are rejecting the valuations they’ve set.
Venture capital has been one of the most popular and profitable sectors in which to operate and invest in the last few years. Traditionally the domain of the ultra-wealthy, pension funds and statutory investors, the sector has delivered returns exceeding 20 per cent a year for many years now.
While private equity and venture capital exposures have been among the top contributors to the performance of some of Australia’s top performing industry super funds. Venture capital gets a little deeper, in that it is tilted towards new companies or those in “start-up” phase. These companies tend to have significantly higher risk and, in many cases, the vast majority will not generate any profits and may not even exist in a few years’ time.
Canva is a classic domestic example that began as a start-up but has since grown into a $40 billion-plus valuation as a private business, based on its funding rounds.
One of the biggest benefits of private investing is that there is less volatility in valuations; in fact, in most cases, the valuation is simply taken to be the value of the business when it last raised capital. The benefit of this is the time it affords management to prove a business model without having to worry about daily share price movements.
Venture capital and private equity companies have been among the most popular source of new IPOs in recent years (for example, Airbnb or Rivian), but many of these newer arrivals have faced significant selling pressure with the Nasdaq and the valuations of most technology companies tanked at the start of 2022.
According to Maximilian Friedrich of ARK Invest, a specialist in the fast-growing, listed technology sector, “one-third of companies that went public through IPOs during the past four years are trading below their previous private valuations.”
Friedrich’s and ARK’s view is that “these data suggest that public market investors are rejecting late-stage and IPO valuations set by venture capitalists and investment bankers.” One prime example is WeWork, which was valued at US$104 billion in 2019 but after finally listing in 2022, is presently worth just US$4.5 billion.
The result is what he describes as a juxtaposition of “record private equity valuations against the severe valuation compression of early-stage public companies in the innovation space during the past year.” This is backed by recent data from PitchBook, which showed that flows into venture capital funds hit multiple records in 2021, including a doubling of investment to US$330 billion and a jump in non-traditional VC investors entering the market in the pursuit of returns.
