Steward Quarterly Highlights - 1st Quarter 2024

By Steward Asset Management - View as Webpage - Institutionalizing Anchor Investing Issue #16

Even though the fundamentals of Middle Market investing remain strong, it is still a buyer’s market and valuation multiples are down approximately 20%. Despite interest rates eating into valuation multiples, we expect this stressful period spurred on by the uncertainty of the cost of capital to pass, and growth to remain strong.

There is an enormous focus on the effect of rates. We do not believe true rate relief is imminent, even with rates being more stable. It is not a call on the Fed, but more that when the moment comes for the Fed to use their loaded gun to lower rates, credit spreads are likely to widen. 

Definitive signs of normalization in the Middle Market come from RSM’s survey, which reports rising capital expenditures among Middle Market companies and business confidence that is outpacing consumer confidence. While we are keenly watching the horizon for new risks, both domestic and international, forces are moving us further along the curve of normalization.  

The Middle Market has been a defensive haven in the private markets as add-on volumes have allowed larger buyout managers to average down their entry valuations. Still, exits have been slow for most. Bloomberg recently tallied that more than 25% of private equity partnerships have not raised a second fund since 2015 and often due to poor distributions, creating a class of zombie firms. The strongest talent is departing to form new firms.

Below we outline seven forces helping to improve deal volume, valuations, and distributions in the US Private Equity landscape.

#1 Rates and Credit Availability. Stability in the cost of capital and the increase in private credit are creating a more stable market for credit availability.  

#2 IPO Activity. There is cautious optimism as each new issue gauges appetite in tandem with IPO pricing dynamics. Additionally, the strong secondary market is laying the groundwork for more IPO exits. 

#3 The US as a Growth Leader. Among developed nations, innovation leadership continues to be concentrated in the US, attracting capital from foreign shores.

#4 Increased Private Equity Firm Launches. Our pipeline has been burgeoning due to the announcement of new fund launches. We expect 2024 to show a marked uptick in average annual 300 buyout launches of the past decade. 

#5 Dry Powder. The persistent hold back on deployments is hitting a critical inflection point. Funds operating on a 4-year deployment and 10-year fund life are watching the sand clock run down.

#6 Constrained Institutional Investors. With distribution rates running at half of the expected pacing, the catch up may create a resurgence. More nimble investors or those underweight are well-positioned to take advantage before the resurgence occurs.



#7 Motivated Sellers. Founders and current private company owners are, more than ever and after a very challenging few years, open to strategic partnerships. Credit needs aside, business decisions have never been more complex. The struggle that began with COVID disruptions in labor and logistics were followed by margin volatility, complex pricing policy decisions, new procurement needs, supply chain enhancements, rising labor costs, employee upskilling programs, and the competitive need for tech enablement.

Lessons learned are engineering an evolution within the private equity industry. Investors are improving terms to position themselves in a front seat position, which is often more achievable when engaging with newer fund managers. This segment of the evolution includes a desire to add risk controls focused on dynamic economics linked to timing and cashflows, taking a chapter out of the continuation vehicle structure and the strategic GP stakes playbook. 

History shows us that private market vintages perform best following stressful periods. As we exit this trough where valuation multiples have contracted, similar to 2001 (post the Tech bust) and 2012 (post the Mortgage crisis), what else should we expect?

With the cost of capital higher, operators will naturally reduce financial engineering and put greater focus on operational improvements. Playbooks can drive strong market share accretion by harnessing technology for stronger client management and business decisions, building pricing policies and developing a program for employee participation. In addition, experience in adjacent markets is a marked advantage. 

Unique operational skills and capabilities as well as the 30% spread between top and bottom decile funds underline the importance of manager selection. Please explore our recent Private Market Observations for a multi-decade look at top and bottom decile returns.

What We Are Reading

Ark Invest. Cathy Wood. The Journey From Monetary Shock To An Innovation-Led Economic Boom. Cathy shares that despite what she considers to be one of the biggest mistakes in monetary policy history, it should result in supporting growth strategies especially disruptive innovations.

McKinsey & Company. Hannes Herrmann, Jamie Koenig, Anna Mattsson and Marc Silberstein. The Equity Story You Need For The Long-Term Investors You Want. Sophisticated investors are more likely to afford a company more time to let its strategy play out, even during volatility. But first, they need a clear equity story.

The Fiftyfaces Podcast. Angela Miller May. Catch up with Angela Miller May CIO of IMRF - What Keeps a CIO Up At Night? A look at IMRF’s decision to manage equity in house or externally, and the objective of investing in emerging managers.

S&P Global. Dylan Thomas and Annie Sabater. Private equity dry powder swells to record high amid sluggish dealmaking. Global private equity dry powder soared to a record $2.49 trillion around the middle of 2023 as sluggish dealmaking limited opportunities for the deployment of uncommitted capital into buyouts and other investments.

Bain & Company. Hugh MacArthur. Global Private Equity Report 2024: Standing up to the Challenge. The long-term outlook remains sound, but breaking the logjam will require more robust approaches to value creation and rapid innovation in liquidity solutions.

Walker & Dunlop. Willy Walker and Dr. Peter Linneman. Most Insightful Hour in CRE, Part 16. Dr. Linneman explains Type II errors, not investing when you should. He shares his outlook for 2024, housing and auto supply, federal and consumer debt, property plays and much more.

Bloomberg. Dawn Lim, Layan Odeh, and Linly Lin. Private Equity’s Slow Carnage Unleashes a Wave of Zombies. A historic shakeup is threatening to snare many small, struggling or fading money managers unable to raise fresh funds.

Institutional Investor. Julie Segal. Private Equity Firms Used to Sell Half Their Companies to Their Competitors. Now They’re Selling Them Back to Themselves. Data shows private equity firms are increasingly handing portfolio companies off to their next funds, rather than exiting the investments.

New York Office of State Comptroller. DiNapoli Releases a Profile of New York’s Small Business Owners. The drive to entrepreneurship has been alive and well in recent years despite the challenging environment.

Nasdaq. Wendy Diamond. Top 10 Tips for Women Entrepreneurs: Insights from Trailblazing Leaders on International Women's Day. While the journey can be both thrilling and challenging, Wendy shares wisdom from those who have paved the way.

Morgan Stanley. 2024 M&A Outlook: Ready for a Rebound. Five trends explain why deal making in 2024 is likely to pick up.

Private Equity International. Helen de Beer. How Does LP-GP Alignment Look at the Start of 2024? One of Dechert’s top lawyers believes the power balance between LPs and GPs is starting to level out. 



World Economic Forum. Saadia Zahidi. How to Rewire Economic Growth for a New Era. WEF shares a new framework that complements traditional growth metrics 

Steward Asset Management uses a strategic partnership approach to building diversified portfolios of primary fund investments. Our aim is to institutionalize anchor investing and capture excess return drivers available in smaller funds. Our lens focuses on next-generation innovation and growth in the Middle Market's healthcare, consumer, industrial, service and technology sectors.

Steward's strategy provides investors with early access to debut funds at an influential moment. Using control-oriented strategies, our capital is a multiplier for large-scale economic growth and progress. Steward's active sourcing identifies exceptional teams with sector capabilities that form a repeatable competitive advantage to win deals and bring value-creation levers to propel companies.

Our consultative partnership approach influences a newer manager's investment process, policies and human capital strategy. Our engagement helps to improve the risk-reward framework with GP stake participation and downside controls.

Headquartered in New York City, Steward is differentiated by a deep pipeline, GP stakes approach, unique assessment tools and extensive relationships within the emerging manager community. The team has an accomplished track record of propelling smaller and diverse asset managers.

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