Occasionally we publish commentary from other sources. This short piece from PitchBook on venture capital’s skyrocketing valuations is a timely follow up to our last note on investment returns 2021.

As Mary Cahill, former Emory University CIO, commented in a recent Fundfire post, “Gains on paper are not the same as money in the bank.”

Speaking of investment returns, the last two years under Covid have been strange days indeed. Half the population can’t make rent, while the other half – anyone with assets – runs the table.

One year ago, in FY2020, university endowment returns averaged 1.8 percent. This year our back-of-the-envelope calculations suggest an average in the low thirties.

It’s anybody’s guess what next year will bring, but we’ll leave you dear readers with these words of investment wisdom from a master of the craft.

“Go for a business that any idiot can run – because sooner or later any idiot probably is going to be running it.”

― Peter Lynch

Best wishes for the Holidays and a great 2022.

— Charles Skorina

VC-backed IPOs are booming, yet public performance this year is lagging

PitchBook, December 4, 2021

Has 2021’s ramp-up in IPO activity been a rush to the exits prior to a change in the market cycle?

Is it just the new normal?

Time will tell, but one thing is certain: US VC-backed IPOs have broken all kinds of records this year, unlocking more than $500 billion of liquid value.

The median company valuation at IPO is nearly 60% greater than its last private valuation. However, our VC IPO index has shown relative underperformance against the S&P 500 since the beginning of 2021.

(hit link for chart)

Long-term performance still shows above-market returns, but inflationary pressure and the increased expectations of interest rate hikes in the coming year have introduced more volatility in the market for these freshly public companies.

These swings have been especially potent in the software space, which represents nearly 50% of the total weight of the IPO index, as the lofty valuation multiples placed on those companies have received a reality check in the face of rising discount rates.

While the majority of the underperformance came earlier in the year, it remains top of mind given the signs of increased market uncertainty—which have been amplified by fresh pandemic-related concerns.

This represents a significant threat to the sustainability of the IPO volumes we’ve seen over the last couple of years, as negative price performance or just general uncertainty will discourage IPO plans for certain startups, especially if they have access to other financing and liquidity options.

We will maintain vigilant coverage of this space as we expect IPOs and their performance to be a leading indicator on the health of the VC industry, as public markets have facilitated the majority of exit value over the last two years.

For more data and analysis, click to download our free Index of Venture-Backed IPOs.

Feel free to reach out with any feedback or questions, or if you would like to discuss the research.

Best,

Cameron Stanfill, CFA, Lead Analyst, Venture Capital

(news@pitchbook.com)

PitchBook research (part of Morningstar) reports on private equity and venture capital.  We always enjoy the read.

————————————————–

CHARLES SKORINA & COMPANY

Our services: recruit CEOs & CIOs, advise on performance and pay, M&A consulting

Our clients: board members, family offices, and institutional asset managers

skorina@charlesskorina.com

www.charlesskorina.com

(520) 529-5677

THE SKORINA LETTER Sign-up

News, Interviews, Research for Institutional and Family Office Investors

Prior

JPMorganChase – Institutional credit, lending, risk management

Ernst & Young – Financial systems consulting

US Army – Russian Linguist, Japan

University of Chicago, MBA, Finance

Michigan State University and

Middlebury Institute of International Studies at Monterey

Culver Academies

The good news is that, according to the current administration, the rich will pay for everything.

The bad news is that, according to the current administration, you’re rich.

— P. J. O’Rourke

Institutional investors delivered once-in-a-lifetime investment performance for fiscal 2021, from about 25 percent at the sleepiest public pensions to 65 percent at Washington University, St Louis.

As the late standup comedian Jackie Mason used to quip, “these are returns even the mafia can’t get.”

Take the eight Ivy endowments, for example.  Their performance soared from a tepid 6.28 percent average a year ago (and ten-year 9.52 percent) to a sizzling 41.75 percent for fiscal 2021 as our chart below shows.

(please hit link for chart)

As of June 30, 2021, the S&P 500 tallied a twelve-month total return of 40.79 percent against the Barclays Agg ETF return of minus 0.3 percent.  Even a plain vanilla 70/30 portfolio rang up about 26 percent.All things equity had a run for the ages, but how long can it last?

Private-market-heavy, risk-on endowments, foundations, and pensions enjoyed their best performance ever, thanks to eye-popping venture capital and private equity returns and good old-fashion leverage.

But here’s the caveat, if history teaches us anything, it’s that nothing lasts forever, be it empires or bull markets.  Everything ends, the only question is when.

And now here’s the bad news

According to Preqin, the unrealized portion of global venture-capital portfolios skyrocketed to $1.33 trillion by March 2021, up from $803 billion in December 2019.

How are multi-asset institutional investors going to handle their asset allocations over the next few years when venture capital marks are up 80 percent, yet nothing is being realized (where’s the cash?) and investment staffs have planned for VC commitments in the 15 percent to 25 percent range.

As Sam Gallo, CIO at the University System of Maryland Foundation puts it, what do you do when an overvalued asset class takes over your book, eats up your risk budget, and threatens your ability to continue allocations across the entire portfolio?  Meanwhile, every VC manager and their cousin is raising a new fund every month and if you don’t re-up, they will never let you in again.

Here’s another pickle.  Let’s say a pension or endowment lays on a one percent bitcoin position that jumped to eight percent overnight.  Should they rebalance back to one percent so as not to reduce their allocations to other asset classes?

Or what if bitcoin drops fifty percent as it has done at least seven times in the past, cutting that new eight percent allocation down to four percent of book?

Endowments and pensions are supposed to be long term investors, so in theory they should hold on to that bitcoin position.

But keep in mind that CIOs get bonuses by minimizing tracking error relative to their benchmarks, especially on the downside.  No board likes to miss benchmarks by more than two percent a year.

What to do?

If you’re a conventional investor and things go well, that’s great.

If you’re a conventional investor and things go wrong, who could have known?

If you’re an unconventional investor and things go well, maybe you just got lucky.

If you’re an unconventional investor and things go wrong, you’re fired.

— Anonymous

Boston Consulting Group’s “Global Wealth 2021” report counts 20,600 UHNW individuals in the US with personal wealth over $100 million.  As a group, they hold about $5.8 trillion in investable assets.

By 2025 BCG anticipates an additional 7,400 ultras will have scaled the $100MM heights, packing an additional $2 trillion in assets to invest.

New family office formations, we suspect, are not far behind.  And that means a need for more chief investment officers.  Lucky us.

But there’s a snag.  Institutional style money management and entrepreneurial success are two different things and too often CIOs and ultras don’t understand each other.

A few months ago, I spoke with one of these ultras, a wildly successful first-generation entrepreneur who was thinking about hiring a money manager for his family office. 

He had just made a fortune selling his retail empire and wanted to bring on an investment head to channel the cash tsunami about to wash up on his shores.

But during our call, it became clear that an endowment style, risk-focused CIO was not at all what he had in mind.

In his words, “the type of individuals you described – institutional CIOs at endowments and foundations – and the way they invest sounds really boring Charles.  I want excitement.  I want someone who can help me do more of what I do.”

He’s not alone.  Most entrepreneurs have a hard time understanding what institutional CIOs do or why anyone would waste their time investing that way.

Diversification?  What’s that?

Groupthink is a phenomenon that occurs when a group of well-intentioned people makes irrational or non-optimal decisions spurred by the urge to conform or the belief that dissent is impossible.

– Psychology Today

It’s hard to find an independent thinker among university endowments these days.  Every board member wants to hire a Swensen clone and every CIO wants to partner with Sequoia.  Group-think and safety-in-numbers has become the new endowment-model-norm.

David Swensen was one of a kind, a different thinker, a pioneer.  Swensen blazed a trail thirty years ago and his first book was called Pioneering Portfolio Management for good reason.  It was all new stuff.  Forget public markets.  Spend your time on private opportunities with less visibility and more upside.

Today that trail he blazed has become a freeway and the endowment model is one very crowded trade.

Richard Ennis, co-founder of EnnisKnupp (AON), points out that in 1994 large endowments with AUM over one billion dollars held on average less than twenty managers in their portfolio.

Twenty-five years later the average was well over one hundred, with some holding close to three-hundred funds (asset managers, commingled funds, and partnership interests, NACUBO Study 2019).

The strategy du jour on campus is mostly about appeasing the VC and PE gods, doubling down with existing managers and anteing up to the spin-offs.  No one wants to be excluded from a new manager or the next flagship fund.

Proliferation drives up costs of course.  With management fees of two percent of AUM plus a twenty percent carry, plus broken-deal fees and every conceivable expense charged back to the fund, the load can run six to ten percent.

As an aside, we hear that Swensen was cutting back on managers and growing more conservative in his final years.  We’ll see what course Matthew Mendelsohn and staff chart going forward, but we suspect there will be headwinds.

Mr. Mendelsohn has the smarts and the will but he does not yet have Swensen’s clout.

Groupthink Happens

A recent paper in the Journal of Risk and Financial Management suggests (as do countless others) that it all begins with the boards.  They set the tone and lead by example, for better or worse.

Our latest Outsourced Chief Investment Officer (OCIO) report below features one-hundred-four firms managing industry assets of $3.27 trillion as of March 31, 2021, an increase of 15% over the prior six months.

By comparison, last year we reported 15.8% growth for the entire twelve-months ending September 30, 2020.

All things equity – public markets, private equity, venture capital — produced a year for the ages and our herd of OCIO providers kept pace with the bulls.  Overall OCIO growth matched Alpha’s broad market index and slightly trailed Alpha’s moderate endowment and foundation diversified style index.

The OCIO Story

Our friend Jon Hirtle, of Hirtle, Callaghan & Co, officially launched the OCIO service model in 1988 (with fellow Goldman Sachs vet Don Callaghan) and it’s been full steam ahead ever since.

(See Jon Hirtle’s iconoclastic guest commentary below –– and his full article OCIO My Foot! here.  We welcome all points of view)

The core idea was to offer a diversified and full-discretion money management function to family offices and institutions who could no longer effectively or affordably manage the money in-house.

OCIO firms offer the proven performance of the best endowment and foundation investment managers at a reasonable price.  And they can replicate the entire investment office with the process and structure to cope with the complexity of modern portfolios and mounting operational and regulatory burdens.

We’ve been charting the growth of the OCIO industry for well over a decade in our annual OCIO reports and the heirs of Hirtle, big and small, seem mostly to have flourished.

Today the industry is bifurcated, highly diverse, intensely competitive, and the nine largest providers on our OCIO list – Aon, Blackrock, Goldman Sachs, Mercer, Northern Trust, Russell, SEI, SSgA, and Willis Towers Watson – with their size and resources dominate the largest segment, corporate pensions.

These nine firms control nearly two trillion in OCIO assets or 60% of the outsourced segment, but from what we hear and see, the market for discretionary asset management services among foundations and family offices shows no sign of slowing.