Nizar Tarhuni: The State of Private Markets and Venture Capital Investing

Episode Summary

Executive Summary: Nizar Tarhouni of PitchBook discusses the private markets landscape, highlighting that private equity-backed companies now outnumber public firms. He cautions advisors about the challenges of retail access to top-tier managers, the smoothed volatility in reported returns, and the impact of rising rates on deal activity. Private credit is presented as a potentially suitable alternative for income-focused investors, but due diligence on loss rates and leverage is critical. The IPO market remains frozen, with many unicorns facing down rounds.

Main Topics: Scale of Private vs Public Markets (Priority: 5/5): Comparison of the number of private equity-backed companies (11,000) vs public companies (4,000-5,000) in the US, and the total NAV of private equity (5% of US equity market cap) and venture capital (2%). Performance and Volatility in Private Markets (Priority: 5/5): Discussion of reported vs actual volatility, with private equity smoothing returns and venture capital showing higher actual volatility. Historical PME comparisons: PE outperformed S&P 500 by 9%, venture by 25%, private credit underperformed. Manager Selection and Persistence (Priority: 4/5): Persistence of returns is not consistent across the asset class; top quartile managers are hard to access for retail. The range of returns between top and bottom quartile funds is wide (>10% annually for PE, wider for VC). Impact of Rising Interest Rates (Priority: 4/5): Higher rates have changed LBO economics, leading to more equity-heavy deals, add-ons, and a shift to smaller transactions. The leveraged loan market is down 80% excluding refinancings, and private credit yields have risen to 11-12%. Challenges for Advisors and Retail Investors (Priority: 5/5): Advisors face difficulties in accessing top managers, committing to long lock-ups, and dealing with illiquidity. The speaker warns that many retail-oriented products may not deliver expected benefits and could be detrimental. Private Credit as a Strategy (Priority: 4/5): Private credit is favored for income and capital preservation, but due diligence should focus on loss rates, covenants, and funding base leverage. The speaker emphasizes benchmarking loss rates rather than yield. IPO Market and Venture Capital Outlook (Priority: 3/5): The IPO market is frozen; many unicorns (800) are unable to go public or raise capital at favorable terms. Down rounds are increasing (15% of rounds), and VCs are focusing on top-tier companies while abandoning the bottom third.

Key Arguments: Private equity-backed companies now outnumber public companies, but the total NAV is only 5% of US equity market cap, indicating a small slice of the overall market. Reported private equity volatility is about half of estimated actual volatility due to smoothing; venture capital actual volatility is 2.5 times reported. Top quartile managers are largely inaccessible to retail investors; newer managers with less track records are more likely to tap the retail market, increasing risk. Private credit can be a good strategy for income, but investors should benchmark loss rates (e.g., 9 basis points to 500 bps) rather than yield, and examine covenants and fund-level leverage. Rising interest rates have made traditional LBOs difficult, forcing larger firms to move down-market with more equity and add-on acquisitions. The IPO market remains frozen; many venture-backed companies are facing down rounds or are unable to raise capital, leading to a 'GP-friendly' market with unfavorable terms for founders and employees.

Data Points: Number of private equity-backed companies in US: 11,000 - Compared to 4,000-5,000 publicly traded companies. Number of venture-backed companies: 50,000 - Companies that have raised a recent round and are still operating. Private equity NAV as % of US equity market cap: 5% - Venture capital is 2%. Median private equity deal size: $50 million - Many deals are smaller, but some firms have $1-2 billion in revenue. Private equity outperformance vs S&P 500 (10-year PME): 9% - Venture outperformed by 25%; private credit underperformed. Annual gap between top and bottom quartile PE funds: >10% - Even wider for venture capital. Percentage of venture rounds that are down rounds: 15% - Up from 0-3% previously. Private credit yield on LBO deals: 11-12% - Up from 4-5% two years ago. Leveraged loan market decline (excluding refinancings): 80% - Overall market down 20% including refinancings. Number of unicorns: 800 - Doubled in the past two years.

Pivotal Quotes: "The returns that are reported on a quarterly basis... there's not an active trading process... firms tend to be very quick to mark up assets and very slow to mark down assets." — Nizar Tarhouni: Discussing the smoothing of volatility in private equity reported returns. "If you're not going to get access to the top quartile managers, which the reality is, you won't... you're not going to get that." — Nizar Tarhouni: Advising that retail investors typically cannot access the best-performing private equity managers. "Private credit, I actually absolutely love. I think it's a great strategy for advisors and institutionals alike." — Nizar Tarhouni: Expressing a positive view on private credit as a suitable alternative for income and capital preservation.

Implications: Advisors should approach private equity and venture capital with caution for retail clients due to illiquidity, volatility smoothing, and limited access to top managers. Private credit may be more suitable but requires rigorous due diligence on loss rates and leverage. The current high-rate environment challenges traditional PE strategies, favoring larger firms with more equity. The frozen IPO market suggests continued pain for venture-backed companies.