Fundraising Report: Regulation, Denominator Effect to Impact Fund Managers’ Abilities to Grow Asset Base

When the Tide Goes Out, could have long-term implications for private markets, according to a recent update from Pitchbook.

A report from Pitchbook notes that asset growth from fund performance and future fundraising are the two most important variables in their estimates, and they are also “the most sensitive to the macro climate.”

To capture the uncertainty of future economic conditions, Pitchbook “have created three scenarios: a good case featuring a return to economic expansion, a base case
involving a moderate downturn followed by recovery, and a bad case leading to more pronounced NAV markdowns across private fund holdings.”

As mentioned in the report from Pitchbook, different asset classes “under the private capital umbrella will also be impacted in different ways.”

For example, portfolio holding values “reported by VC and PE fund managers in 2022
have been minimally impacted by the sell-off in global public equity markets, even though LP fund interests are often trading at 70 to 80 cents on the dollar in the secondaries market and skepticism among LPs is high.”

According to Pitchboook’s latest benchmarks report, VC fund NAVs “reversed course through Q3 2022, and we expect valuation markdowns to catch up with falling public growth stocks in 2023.”

Assuming a renewed bull market does not take hold quickly, NAV growth “will likely be negative in the near term for VC and PE.” Pitchbook looked at “the historical record of annual returns during market downturns, as well as public market comparables, to provide guideposts for our NAV growth estimates across the five asset classes in this analysis.” Pitchbook utilized “a variation of the Takahashi-Alexander (TA) cash flow model to create an interplay between existing dry powder available to private fund managers and the NAV path each vintage is expected to follow in the forecast period.”

As noted in the report:

“For future fundraising, regulation and the denominator effect will have dampening effects on fund managers’ abilities to grow their asset base. LP sentiment on this front is quite mixed. A recent Coller Capital survey reported that investors expect private capital to be a strong source of returns for allocated capital over the next three to five years.”

Despite this, 42% of LPs expect “to reduce their pace of new commitments in the near term due to the denominator effect.” Shorter-duration asset classes, “such as infrastructure and private credit, are likely to see continued investor interest should the reset in benchmark rates persist through 2023 and beyond, but even these asset classes will not be immune to a recession.”

As noted in the update:

“Our estimation methodology fit a flexible linear trend model to historical fundraising. We then adjusted a baseline growth trend a net +/-3% in our good and bad cases, reflecting strong and weak fundraising environments. We also added a distribution yield component to reflect the realized returns to LPs that are redeployed in future fund commitments. Distributions estimated from the TA model feed into the distribution yield estimates, which in turn feed into the fundraising model used to generate the forecasts.”

This methodology ties “the cash flow and NAV models to the fundraising estimates and vice versa.” All in all, Pitchbook estimates for AUM “range from $11.2 trillion to $16.1 trillion over the next five years, although the proliferation of mega-funds and shifting market dynamics within asset classes will likely cause variance in the actual figures realized.”

Nicolas Moura, CFA Analyst, EMEA Private Capital, notes:

“2022 saw $463.4 billion raised across 599 funds—healthy figures, given the macroeconomic backdrop. Indeed, megafunds, meaning funds of over $5 billion, had their second-best year in terms of value, raising $219.2 billion and representing 47.3% of the total for PE, truly supporting the year’s fundraising. 2022 also saw conditions tighten across the globe as most of the developed economies increased interest rates in response to spiraling inflation.”

As mentioned in the report, this in turn “shifted the dynamics of PE from riding a wave of cheap leverage for the past decade to tougher and costlier borrowing.”

LPs became more cautious in “deploying their capital throughout 2022, in many cases decreasing the size and number of commitments to the benefit of trusted, experienced GPs.”

In fact, first-time funds “had their lowest fundraising in nine years, dropping some 36.7% % YoY, while experienced managers had their third-best year and dropped only 13.3% from record 2021 fundraising.”


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