Private Wealth

Weekly Research Briefing: Summertime Treats

August 15, 2023

Investors have $5 trillion of their money market funds earning away at a 4-5% rate. As inflation slows and the economy remains solid, what is an investor to do with all this cash?

At some point, interest rates are going to move lower with inflation and that cash rate might have a 3% handle. Falling interest rates in a good economy should provide a tailwind for risk-based assets. We are already seeing much evidence of investors dialing up their risk appetites into the public and private areas of equity, credit, and real estate. Yes, even distressed commercial real estate. Six to twelve months ago, just mentioning distressed CRE would get you thrown out of an investment meeting. But now, some of the smartest investors in the world are raising money to buy it. Elsewhere, we are seeing companies look to use their stock currency value to make major strategic acquisitions, while others lift the hood on the IPO market to raise money for expansion, balance sheet health or just to cash out. The financial markets are warming up so grab a Dilly Bar and keep reading because I have some thoughts for you.

Public Equities have had a fast start to 2023 versus Private Equities...

The major U.S. equity indexes are up 9-18% year-to-date with the largest market caps leading the smaller market caps. The foreign equity indexes have performed equally strong in their local currencies. By comparison, the average global PE fund returns for the largest private equity firms look to be up in the mid-single digit percents for the first half. While it is disappointing for privates to lag publics for the first half of the year, we should remember that the S&P 500 was -19.4% in 2022, and this included a near 30% drawdown for the first 10 months of the year. The stock markets were bound to have a bounce once investors realized the Fed induced recession was not going to be as bad as feared. That bounce has continued as investors realized that there may not be a recession at all in 2023 and that the Fed could be finished raising rates for this cycle.

While historically the private equity asset class has better returns over the long term as compared to public equities, it doesn't mean that it will win over every short-term timeframe. Stock market movements and their public company valuations are influenced by many short-term factors from Fed speaker comments to talking heads on financial TV to even Reddit chat rooms. Private equities do not have daily valuation movements because they are not traded daily on an exchange. Investors in private equities are focused on the longer timeframe and they want management focused on the long-term goals of the enterprise, not the daily moves in the stock price. Next time you run into a recently taken private CEO or CFO, ask them if they miss the TV interviews, the quarterly conference calls, and all the meetings with institutional public stock investors. I'll bet $5 they break into a big smile. An individual company's operating performance and how it allocates and distributes its capital will determine what a company is worth in the long run. And private company management teams get to spend all of their time working on it.

The early lead of the public equity markets is not a negative for private equity values. The IPO markets shut down and the M&A markets slowed significantly as a result of last year's retreat in equities. The bounce in stocks this year has led to a reopening of IPO activity (Cava Group and Oddity Tech are two recent examples). And higher valuations for acquisitive public companies has rebounded the currency value of their stock price leading to more M&A recently. Rising public values can also make private company sellers feel like they are making a better deal when the investment bankers come calling with buyout proposals. Monetization activity may be a good thing for PE funds after such a quiet 2022.

Below is a chart of the annualized 10-year time weighted returns through the first quarter of 2023. This private equity data is from Hamilton Lane, and it is one of the most complete sets of returns within our industry. The 'All PE' series is comprised of the net returns for all Buyout, Venture Capital and Growth Equity funds in our database. If you look closely, you will see that over the 22-year window of 10-year returns (thus looking at 32 years of data), long-term private equity returns were beaten only twice. Once by U.S. small cap value in 2010 (remember Webvan and in 2000?) and once by the S&P 500 in 2018-2019 (remember the 2008 global financial crisis?). In any other time, it would have been difficult to not have exposure to private equity funds.

Past performance is not an indicator of future results.
See definitions below.1

So, if you are comfortable with the facts, feel the global economy and inflation are in a good place, and you want to increase your risk exposures, then I have another chart for you below. What this shows is how PE funds performed over 3-year windows versus the S&P 500 over different market regimes sliced by performance. The data goes back to 1995 so there are plenty of market environments here. During the period of times where the S&P 500 was ripping higher at a 15%+ rate, private equity funds continued to outperform but at a smaller rate. During all other timeframes, private equity funds significantly outperformed the S&P 500. 

Past performance is not an indicator of future results.
Annualized 3 year returns from 1995 – Q3 2022.
In this example, ”High” return environments are considered Public Market 3Y annualized returns from 10% to greater than 15%; “Low” and “average” return environments are considered Public Market 3Y annualized returns of less than 5% up to +10%. 
Source: Data from 1995-2023. Public Markets are represented by the S&P 500 Index. See definitions below.1

2023 Hamilton Lane Market Overview

Last week's CPI release was another green flag for investors...

As inflation continues to fall at a better-than-expected rate, investors are rotating their thinking from 'when will the next Fed hike be' to 'when will the first Fed cut occur'. With 6-month T-bills yielding 5.5%, it will be tough for them to remain here as inflation retreats to a 2-3% range. Remember that shelter inflation will be an increasing weight moving forward so a 2% future inflation rate is not out of the question if the monthly rate continues to grow at only +0.16%.

The core CPI, in particular, adds to recent data that calls into question whether the central bank will need to raise rates again this year, as most officials had projected in June.

The new numbers lowered the three-month annualized rate of core inflation to 3.1%, the lowest such reading in two years, from 5% in May.

“My God, that’s incredible,” said Laurence Meyer, a former Fed governor. “There’s absolutely no question that core inflation has turned the corner faster” than the Fed anticipated...

“I believe we may be at the point where we can be patient and hold rates steady,” Philadelphia Fed President Patrick Harker said in a Tuesday speech.

Boston Fed President Susan Collins said she also thought a pause could be appropriate soon. “My read of the data that we have so far is that we are near or perhaps at a sufficiently restrictive level of monetary policy to hold for some time,” she said in a Monday interview.


Ed says the Fed is done...

The FOMC can take the rest of the year off. The federal funds rate is now restrictive enough to bring inflation down without causing a recession, in our opinion. The banking crisis in March, Moody's recent downgrade of several regional banks, and the Fed's latest Senior Loan Officer Opinion Survey all confirm that credit conditions are tightening. The economic data confirm that the economy remains resilient with the Atlanta Fed's GDPNow currently forecasting a 4.1% increase in Q3's real GDP. Today's CPI report for July confirms that inflation remains on a moderating trend.

Yardeni Quick Takes

Mark sees a perfect Fed landing...

Falling inflation is not just good news for future homebuyers, but it is excellent news for everyone...

@NewsLambert: #NEW Goldman Sachs: "We are forecasting 30-year fixed mortgage rates will end 2023 at 6.4% (per the Freddie Mac Primary Mortgage Market Survey) before normalizing to 5.9% in 2024"

Consumers see it and are becoming more interested in big ticket spending...

The Daily Shot

Besides plentiful jobs and rising wages, the U.S. consumer also sees a new high in their home value...

The total worth of U.S. homes hit a record $46.8 trillion in June, overtaking the prior all-time high of $46.6 trillion set a year earlier, as a shortage of homes for sale propped up housing values...

The value of U.S. homes rose 0.4% ($166.2 billion) from a year earlier in June and 19.1% ($7.5 trillion) from two years earlier. The housing market has now offset the $2.9 trillion decline in value—set off by rising mortgage rates—that occurred from June 2022 through February 2023.

Today’s housing market is unique because home values are at a record high even though demand is sluggish. Despite lukewarm demand, there aren’t enough homes to go around because so few homeowners are selling. This imbalance between supply and demand is keeping values afloat.

“The dominance of the 30-year fixed rate mortgage in America is propping up home values,” said Redfin Economics Research Lead Chen Zhao. “Tons of homeowners scored an incredible deal during the pandemic: a 3% mortgage rate for the remainder of their 30-year loan. Now they’re staying put because moving would mean taking on a rate that’s twice as high. This means buyers who are in the market now are duking it out for a very small pool of homes, preventing home values from plunging.”


Homeowners weren't the only ones to score an incredible deal by locking in 2-3% rates for long maturities...

So did the CFOs of the largest companies which has not only permanently lowered their interest expense, but also sent the maturity wall out into the next decade.

Because many companies wisely took advantage of the extraordinarily low interest rates of recent years to lock in debt, the burden of servicing their debt is also extremely light today. Despite a 10-year US Treasury yield of 4% and a US investment-grade yield of 5.5%, S&P 500 income statements report an effective interest rate of just 3.3% on their debt. While interest coverage ratios have dipped in recent months alongside weakening earnings and rising interest rates, they nonetheless rank in the 80th historical percentile for the median S&P 500 firm and in the 95th percentile for the aggregate index. And with nearly 50% of S&P 500 debt not set to mature until after 2030, corporates and their earnings should remain largely insulated from higher interest rates for years to come.

Goldman Sachs

Small cap companies did not extend debt maturities like their large cap peers...

Most small cap long-term fixed debt come due between 2024-2029. But smaller companies tend to grow faster so it may be easier to grow out of their debt. And with the equity markets now rising, small cap companies could tap the secondary markets to improve their balance sheets, which many have been doing recently.


The IPO market has been on an 18-month sabbatical, but it is now building out its reservation list through year end...

Just $14.1 billion has been raised through initial public offerings on US exchanges this year as of August 7 – a 27% decline from same period last year and a 94% plunge from 2021, according to data compiled by Bloomberg.

“It feels to us that the beginning to middle of 2024 is more likely to be active than the balance of this year, but the pickup in activity will be gradual,” David DiPietro, head of private equity at T. Rowe Price, said.

“The market is ready for this, it’s just that the companies are choosing for one reason or another to take their time,” said DiPietro.

The spread between what a company believes it’s worth and what investors are willing to pay has been among the key hurdles for an IPO market that’s been shut for 18 months. Companies will need to become comfortable with economic stability and an expectation they can deliver on their forecasts, investors and bankers said.

“It’s not a question of whether there is investor demand but if the investor demand is at a price that matches the needs and desires of our corporate client base,” said Keith Canton, head of JPMorgan Chase & Co.’s Americas equity capital markets group.


As economic growth continues, inflation falls and the Fed retreats from its recessionary outlook, Wall Street has followed...

Here is a list of those who have left 'Camp Recession' and those who remain. I'd expect that once summer ends and the flip flops are traded for Sam Hubbard's, you will see many fewer bears.


I will also bet that with $5+ trillion in cash sitting in investors accounts, there will be many 'BUY' ideas hitting your email once summer ends...


If you needed one more risk confidence boost in your life, just look at what UBS did last week...

When UBS was forced to buy Credit Suisse back in the spring, they were given a large guarantee from the Swiss government to make sure the deal closed in record time and with little due diligence. At the time, there were so many global banking worries caused by the move higher in rates, falling CRE values and the evaporation of SVB, that a backstop guarantee was the only way to get the UBS BoD on board. Fast forward five months and UBS elected last month to scrap the backstop. The improvement in the markets and the lack of any significant skeletons has given UBS the confidence to take care of all future problems with their own balance sheet. Proscht!

UBS may be implicitly starting to admit that buying Credit Suisse was the deal of the decade.

On Friday, the Zürich-headquartered bank said it was giving up the loss-protection agreement it negotiated with the Swiss government when it acquired troubled rival Credit Suisse. Under the deal, the public purse would have covered nine billion Swiss francs of losses, equivalent to about $10.3 billion, on Credit Suisse’s portfolio of noncore assets as long as UBS picked up the first five billion francs. UBS also terminated a liquidity backstop it had with the Swiss National Bank and paid back a loan Credit Suisse had taken out with the central bank.

You might assume investors would be displeased by UBS giving up free insurance for no apparent gain. Yet its shares jumped almost 5% on the news.


In the world of mega-cap stocks, the market cap of Novo Nordisk passed the entire GDP of its home country, Denmark, last week...

Thanks to a new study showing Wegovy cuts cardiovascular events by 20% and a better-than-expected earnings outlook. The next record on deck will be a +10% outperformance versus LVMH which will make Novo Nordisk the largest market cap in Europe.

Novo Nordisk, the Danish pharmaceutical group behind a best-selling obesity drug, has lifted its annual sales forecast as it expands its manufacturing capacity to tackle supply chain bottlenecks.

The drugmaker, best known for its new weight-loss medicine Wegovy, now expects sales to grow 27-33 per cent this year and operating profit to climb 31-37 per cent, smashing its previous forecasts.

The improving outlook for Novo was also down to higher than expected demand in the US for Ozempic, its diabetes drug. Some clinicians have been prescribing Ozempic, which contains the same active ingredient as Wegovy but is designed for diabetics, to patients who want to use it to tackle obesity.

The new forecasts from Novo factor in periodic supply constraints, as the company has struggled to keep up with demand for its obesity drug. Wegovy is only available in a handful of markets, with the majority of sales in the US, where supplies of some lower doses of the drug are restricted to ensure existing patients can rely on a continuous supply.

“It is not often that you have a 100-year-old company and you’re still growing at 30 per cent,” Lars Fruergaard Jørgensen, Novo’s chief executive, told reporters on Thursday.

Financial Times

Not to be outdone, Novo's main obesity drug rival, Eli Lilly also beat earnings and increased its financial guidance last week...

LLY Q2 revenue $8.31B vs. est. $7.58B;
Q2 adj EPS $2.11 vs. est. $1.98;
2023 revenue guidance increased by $2.2B to range of $33.4 to $33.9B;
also benefits after Novo Nordisk SELECT trial data showing 20% reduction in cardiovascular events.

Hammerstone Markets

Sales and earnings accelerations are often good news for company valuations as this 1-year chart shows...

As we mentioned, rising stock prices are increasing the appetites of companies to do large strategic deals...

Last week we saw luxury retailer Tapestry (Coach, Kate Spade, Stuart Weitzman) offer to pay $8.5B cash for Capri Holdings (Versace, Michael Kors, Jimmy Choo). The price paid was a 65% premium to CPRI's stock price. An $8B bank line of financing will help close the deal. Investors should probably expect some stock financing in the future to help get the leverage below 2.5x Debt/EBITDA.


And then over the weekend, Cleveland-Cliffs made a public run at U.S. Steel which then put itself in play...

US Steel on Sunday rejected a $7.3bn acquisition bid from rival Cleveland-Cliffs, the largest North American producer of flat-rolled steel, hours after it said it had hired financial advisers to evaluate offers for the company.

Cleveland-Cliffs said it proposed a shares-and-cash acquisition for a total of $35 per share of US Steel stock, representing a 43 per cent premium on US Steel’s closing price of $22.72 on Friday, but that the offer was rebuffed. US Steel was valued at $5bn at Friday’s closing price.

Earlier on Sunday, US Steel said it was considering strategic options and had already received multiple unsolicited bids that ranged from the possible acquisition of the whole company to specific assets.

Financial Times

Cleveland Cliffs

This is the perfect quote to illustrate the difference between private and public ownership...

"The best private equity firms are very good at offense, but they're exceptionally good at defense. When something goes wrong, it’s their mess and they fix it."

- Sachin Khajuria, former partner at Apollo Global


The quote above could not be more perfectly suited for the future of Simon & Schuster...

Viacom (now Paramount) was one of the more challenging owners to be a part of given their historically wide range of entertainment assets and more volatile boardrooms and management team. KKR has a good track record in publishing and the 1,600 Simon & Schuster employees should be excited to participate in an equity ownership program like the one that just rewarded their peers over at RBmedia which KKR just sold.

Paramount Global and KKR today announced the signing of a definitive agreement pursuant to which KKR will acquire Simon & Schuster for $1.62 billion in an all-cash transaction...

After the closing of the transaction, Simon & Schuster will become a standalone private company and will continue to be led by Jonathan Karp, President and CEO and Dennis Eulau, COO and CFO of Simon & Schuster.

“All of the executives at Simon & Schuster who met with KKR came away from those conversations impressed with the depth of KKR’s interest in our business and their commitment to helping us grow, thrive and become an even stronger company,” said Jonathan Karp. “With KKR’s support, we look forward to collaborating on new strategies that will enhance our ability to provide readers a great array of books and to give authors the best possible publication they can receive.”

Simon & Schuster has an outstanding reputation in book publishing, in addition to sustained, strong operating performance and double-digit revenue growth in the first quarter of 2023. KKR expects to advance the company’s position as one of the world’s best-known publishers and distributors with more than 36,000 titles across adult, children, audio and international categories.

In addition to investing in all areas necessary to establish Simon & Schuster as a standalone entity, KKR intends to support numerous growth initiatives, including extending Simon & Schuster’s strong domestic publishing program across various genres and categories, expanding its distribution relationships and accelerating growth in international markets.

KKR will also support Simon & Schuster in creating a broad-based equity ownership program to provide all of the company’s more than 1,600 employees the opportunity to participate in the benefits of ownership after the transaction closes. Since 2011, KKR portfolio companies have awarded billions of dollars of total equity value to over 60,000 non-management employees across more than 30 companies.

Simon and Schuster

While regulated banks exit many areas of consumer finance, private credit companies are filling the empty space...

It is good not only for the new entrants to the market, but also good for consumers and the economy who won't be shut out of needed financing.

Private credit firms are raising billions of dollars to grab a share of the $5.2 trillion market that includes US consumer debt, seizing on a growth opportunity while the industry’s traditional lenders are in disarray.

Direct lenders such as Ares Management, BC Partners, KKR & Co., and Medalist Partners in recent months raised the money for funds designed to lend to consumer financing companies. Providers of auto and consumer loans have been unable or unwilling to tap their usual funding sources, namely regional banks and securities sales backed by assets like loan portfolios.

The private credit firms see a chance to increase returns for their investors and to diversify their offerings, lessening the focus on increasingly competitive corporate loans without adding an unmanageable amount of risk. While the more-opaque consumer debt market is vulnerable to a downturn in the economy and a given sector can be hit by defaults, loans backed by assets like real estate or autos can be attractive.

“Institutional funds may not want to increase their exposure to venture debt or corporate buyouts in an uncertain macroeconomic environment,” said Evan Carruthers, co-chief executive officer at asset-based private lender Castlelake. “But we believe they view asset-based private credit as offering similar returns to corporate debt with potentially less risk,” he said, adding this debt tends to be investment grade but with higher yields.


Things that don't happen in a recession...

Credit leader Oaktree is planning a private credit fund the size of a blue whale.

Oaktree Capital Management is looking to raise more than $18 billion in what would be the largest-ever private credit fund, according to people with knowledge of the matter.

The $179 billion alternative investment manager is raising a 12th fund, called the Oaktree Opportunities Fund XII, for its opportunistic credit strategy, said the people, who asked not to be identified because they’re not authorized to speak about it.

It’s the latest example of the booming private credit market with investors eager to snap up rich returns in an area previously ruled by Wall Street banks. Oaktree, an early pioneer of distressed debt investing, says its opportunistic credit strategy is designed to generate returns from a wide range of private investments. The fund managers specialize in buying claims on discounted assets and are active in corporate debt restructurings.

Fundraising expectations could still change based on investor demand and economic conditions. A representative for Oaktree declined to comment.

In the second quarter, there were 34 new private credit funds that raised about $71 billion, more than double the previous three months, according to data from industry research firm Preqin.


RE shorts beware. A top real estate investor is about to unleash his hounds on the distressed CRE market...

Starwood Capital Group, the firm led by Barry Sternlicht, is in preliminary talks with potential investors for a new opportunistic real estate fund, according to people with knowledge of the matter...

Sternlicht has said that the company’s employees are “foaming at the mouth” to seize on mounting distress in the commercial-property market. The rise in borrowing costs has pressured property prices, sending values falling 16% from a peak in March 2022, according to real estate analytics firm Green Street. Some landlords have also defaulted, often in a bid to renegotiate debt terms.

More tricky situations could be on the horizon as lenders and borrowers confront looming maturities on real estate loans. Nearly $1.4 trillion of debt on commercial property is maturing in 2023 and 2024, according to the Mortgage Bankers Association.


The property insurance markets seem to get weirder with every passing month...

@EricFinnigan: Home builders starting to see impact on new home sales from recent changes in property insurance costs and availability. Effect is concentrated in CA and FL.

With an EV fuel cost equivalent of 200 miles per gallon, it is no surprise that renewable electricity generation is taking off at lightspeed...

Across the country, a profound shift is taking place that is nearly invisible to most Americans. The nation that burned coal, oil and gas for more than a century to become the richest economy on the planet, as well as historically the most polluting, is rapidly shifting away from fossil fuels.

A similar energy transition is already well underway in Europe and elsewhere. But the United States is catching up, and globally, change is happening at a pace that is surprising even the experts who track it closely.

Wind and solar power are breaking records, and renewables are now expected to overtake coal by 2025 as the world’s largest source of electricity. Automakers have made electric vehicles central to their business strategies and are openly talking about an expiration date on the internal combustion engine. Heating, cooling, cooking and some manufacturing are going electric.

As the planet registers the highest temperatures on record, rising in some places to levels incompatible with human life, governments around the world are pouring trillions of dollars into clean energy to cut the carbon pollution that is broiling the planet.


We will all look forward to the eventual return of Front Street...

Originally called Lā-hainā — which roughly translates as “cruel sun” in the Hawaiian language, a nod to the area’s dry, sunny climate — the town was known before the fire as a place where one could reflect on centuries of Hawaiian history simply by walking around.

“Many people don’t understand that Hawaiians have been in these islands for nearly 2,000 years,” said Ronald Williams, an archivist with the Hawaii State Archives who has researched Lahaina for decades. He likened the city to global capitals like Mexico City, where different layers of history are visible. Walking around Lahaina before the fire, Mr. Williams said, was a chance to listen to “voices from the 18th century that are clearly wanting their stories to be told today.”...

Yes, many of Lahaina’s old wooden storefronts had gone from housing fish markets to high-end tourist spots like Tommy Bahama and Cheeseburger in Paradise, but the town maintained its charms. Mr. Hedani said the fabled beach areas on Oahu that Hawaii is best known for held nothing on Lahaina. “To me, Front Street is better than Waikiki,” he said.

Mr. Kaina, the tattoo artist, said he never took for granted the town’s stunning sunsets, temperate climes and pristine beaches. He recalls fondly nights spent with his family feasting on fresh-caught fish and working alongside laborers from around the world in the nearby pineapple fields.

“You’re sitting there, and you see the islands in front of you and the water, and the whales are jumping, and even as a local, I’m like ‘Bro, is this real?’” he said. “The sunset looks fake every time I see it.”


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Private Equity: A broad term used to describe any fund that offers equity capital to private companies. For the data in the chart, all private equity is comprised of Buyout, Venture Capital, and Growth Equity funds.


MSCI World Index: The MSCI World Index tracks large and mid-cap equity performance in developed market countries.

S&P 500 Index – The S&P 500 Index tracks 500 largest companies based on market capitalization of companies listed on NYSE or NASDAQ.

MSCI USA Small Cap Value Index – The MSCI USA Small Cap Index is designed to measure the performance of the small cap segment of the U.S. equity market.

The information presented here is for informational purposes only, and this document is not to be construed as an offer to sell, or the solicitation of an offer to buy, securities. Some investments are not suitable for all investors, and there can be no assurance that any investment strategy will be successful. The hyperlinks included in this message provide direct access to other Internet resources, including Web sites. While we believe this information to be from reliable sources, Hamilton Lane is not responsible for the accuracy or content of information contained in these sites. Although we make every effort to ensure these links are accurate, up to date and relevant, we cannot take responsibility for pages maintained by external providers. The views expressed by these external providers on their own Web pages or on external sites they link to are not necessarily those of Hamilton Lane.

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