2023 - What's Ahead?
I always thought that stagflation was a theoretical idea from economics class, but here we are, and it's hard to put any other label on our current environment and what's ahead. 2022 was tumultuous, and the feeling of looming uncertainty has shown no sign of letting up in 2023.
Despite the chaos, we think there are many ways to put money to work intelligently in this evolving market, where private investments can play a significant role in investors' portfolios. And while the future is hard to predict, we remain optimistic, as many investors are still under-allocated to private assets relative to their long-term targets.
Looking at the year ahead, here are a few themes we're thinking about.
Lots of Dry Powder
Venture Capital funding saw a decline in 2022 from its peak in 2021, but still managed to cross the $200B threshold, making it the second-highest year ever for VC investment. The energy sector specifically was the only sector that saw an increase in funding, demonstrating the strength of the industry despite broader economic slowdown. The increase in investment was driven in part by major legislative efforts, such as the Inflation Reduction Act, but highlights the idea that key investment areas will continue to see growth.
And with considerable funding raised in prior years, there is ample capital to be deployed into deals that look far cheaper today than they have in recent memory. While vintages from 2021/2022 that were heavily deployed at 'higher prices' could suffer, newer vintages in 2023 could thrive from the reset we're experiencing.
For emerging managers, raising will be tough, but isn't it always? While we expect a dip, we believe that investment interest at the LP level will not completely erode, but rather will drive preference to managers with uniqueness around strategy, defensibility, a true niche, and, where possible, a countercyclical approach.
For entrepreneurs, we are with you – we don't want to see funding evaporate, and we expect that many investors feel the same. Those who can ride it out for longer periods of time can be less concerned with the short-term uncertainty and keep their heads down.
Overall, our view is that real innovation creates value, no matter the financial climate. It's hard to rush real progress, particularly in sectors with longer cycles – ex. climate tech, life sciences, deep tech, or elsewhere.
A New Lens of Analysis
As many are also recognizing, we see a clear shift in investor preferences to more financially healthy companies – profitability, rather than top-line growth at all costs, is taking precedence.
When money was cheap at the top, investors (especially fund managers) were incentivized to deploy into anything and everything, and fast. Now that money is no longer free, the tide has gone out a bit and we've seen who's been swimming naked; it makes sense that the dynamic is changing.
But this is not a bad thing. As Howard Marks has stated these past few years, we have been living in a "Low Return World" where "it [has been] hard to achieve good returns dependably and safely." So while forward-looking return expectations have been less attractive these past few years, we like to think that price and strategy adjustments will help drive more favorable future outcomes for investments made in 2023.
Patient and contrarian investors willing to be picky and conduct thoughtful analysis can take advantage of the current market to place bets at better entry points compared to those simply engaged in FOMO investing and party rounds. What happened to scooter startups?
There is a lot of talk in equity markets now about value beating growth over the coming years. A similar theme may be true in privates. It's never a bad idea to invest in a healthy, growing business with strong fundamentals at a good price.
On the company side, fundraising and cash preservation certainly present serious challenges, but those that can focus on real return on investment vs. reckless spending could emerge very well-positioned for the long haul.
As with all asset classes, diversification can play a meaningful role in privates, as not all private investments are necessarily correlated. Investors can develop a private market framework that takes this into consideration with a portfolio of sectors, stages, geographies, fund vintages, and even structures.
For discretionary investors with less restrictive mandates, we can expect to see more creativity in terms of deal structuring and investment types in private markets this year. It is important to call out discretionary as the view on private markets is broader than simply VC funds investing in high-risk, high-reward startup opportunities.
Investors should fully understand their own liquidity realities to plan accordingly based on future cash outflows, capital calls, etc. Overall, however, we expect investments with mixed liquidity profiles at both fund and direct levels to become more appealing (income generation, debt, revenue-based financing, warrant coverage), as complements to the more traditional instruments (priced equity, convertible debt, SAFE) that we are used to seeing in these markets.
Crypto has taken a beating from more than just these macroeconomic factors – continued regulatory uncertainty mars the industry and rampant fraud has left more than a sour taste in the mouths of many investors.
Despite these obstacles, "core" crypto assets, specifically BTC and ETH, have maintained significant value. Of course, they have experienced significant drops from peak prices, but not to the degree one might expect given everything that's gone wrong. While new institutional adoption may be slower based on these real counterparty and regulatory risks, it seems likely that many individual investors will continue to increase their exposure. For example, it can be said with near certainty that the number of people owning 1 BTC at the end of 2023 will be higher than it is today. It is our belief that interest in core crypto assets will persist as individuals and other investors continue to build their portfolios.
Expected volatility and a bumpy ride but seemingly a bright future for at least BTC and ETH over the coming years as the global financial system continues to evolve and becomes more digital.