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Steward Quarterly Highlights 1st Quarter 2022

Steward Quarterly Highlights 1st Quarter 2022
Navigating Middle Market Innovation

Themes This Quarter
Pacing
The Ukraine-Russia conflict is testing a complex web of geopolitical, financial, cyber, energy and mining relationships. This fragility builds on the already supply-constrained inflationary environment putting pressure on interest rates and continued supply chain dislocations. Onshoring trends along with more defensive postures for portfolio construction should continue for the remainder of the year. Healthcare, technology and environmental imperatives helped define the last few years. However, defense is now moving to the center stage.   
The Fed’s intention to continue to raise rates, though exerting some short-term pain, is evidence of their confidence in the medium to long-term economic strength in the US. While price inflation has accelerated, there is some concern that CPI, as constructed, may not fully reflect the run-up in housing, energy and labor prices. If as we suspect, these are only partially reflected in the figures, American consumers may be in for a bumpy ride. 
 The added complexity, emblematic of 2022, underlines the need for (and rewards) active, engaged management, the hallmark of private equity. Following such strong realized and unrealized returns in 2021, vintage risk increases with heightened valuations. These risks are driving investors to invest earlier at more attractive levels.  As a backdrop, the strong US economy looks likely to support continuing private equity returns, which have proven resilient over decades with a relatively low historical loss ratio at the fund level. 
One mark of success is the embedded hangover of public listings captured within private equity portfolios following a wave of IPO exits. This should drive increased payment-in-kind distributions throughout 2022. Until that is complete, there is unwelcome complexity in asset allocation and pacing decisions for institutional investors. Moreover, it continues to restrict capital from re-deployment.
Innovation Bubbling Up in the US Middle Market
Below the scope of the large buyout arena, burgeoning with mega-funds, is the innovative US Middle Market, home to companies with revenues less than $1 billion but more than $10 million. The Harvard Business Review recently decried this 200,000 company universe equivalent to the fifth-largest economy in the world.
Smaller and newer private equity managers keep capital flowing to owner-managed Middle Market companies, often sourcing non-competitive transactions or, when competition exists, winning deals based on strategy and execution, not just price. This is a market of local winners with the potential to be future national and international champions.
Recent deals in the Middle Market illustrate that winners bring both old-world expertise as well as innovation. We note increasingly deal flow combines expertise across life sciences, industrial processes, healthcare and technology specialties. These combined sector skills have been directed at notable precision therapies, faster delivery times and AI-based population management opportunities.  
Technology component recycling is another highly fragmented business facing accelerating demand, notably for responsible management of chemicals and data removal on devices and EVs at the end of their life. The capital-intensive infrastructure required to meet future demand has been slow to materialize, supporting valuation.
Preventative health and wellness trends are driving opportunities for consumer and cosmeceutical companies. From Coke to Kombucha, beef to green proteins and the rise of supplements, consumables reflect changing tastes. The combination of technology, consumer and industrial participants helps manage supply chains, ingredient procurement, product development and kitting. Large consumer and industrial strategic buyers are spending less on R&D and replacing it with acquisitions once distribution channels have shown promise.
Post-COVID-19, healthcare has remained a more significant allocation among Middle Market investors. What began as fear over hospital bed shortages in 2020 will continue as elder-care demand accelerates. Healthcare opportunities are also being widely sourced by industrial, technology and traditional healthcare teams addressing precision medicine, training, drug delivery and faster clinical trial methodologies. Demand is growing for better access, transparency and inclusion across medical products and services.
Finally, cyber-security concerns have multiplied in recent weeks, amplifying the risk to data-rich and increasingly web-based companies. Complex energy delivery and transition initiatives as well as adoption of 5G technology are set to continue to drive a groundswell of risks and opportunities to reduce cyber attacks.  
“Talent wins games but teamwork and intelligence win championships.” Michael Jordan
Cultural Literacy
Buying companies in the Middle Market is not a straightforward process. The culture of private equity dealmakers is often unrelatable to lower Middle Market business owners. Owners are de facto the subject matter experts on their growing company. The National Center for the Middle Market estimates that 90% of Middle Market companies that sell or merge have “little or no previous experience” in M&A. In contrast, private equity players are by their very nature M&A experts.
Growth equity and small buyout teams that are both relatable and bring specialty experience can leap ahead of other buyers, mainly because they can more readily acknowledge the accomplishments and strategic goals of the current management team. Owners recognize that while capital channels are interchangeable, aligned teams can springboard a company.
When it comes to compiling teams that steward companies, it is imperative to recognize that the who matters more than the price. Part of this relatability is found in groups with similar backgrounds or across cultural and gender lines. The relatability of teams on both sides of the table benefit from inclusive practices. The expectation is that an increased number of diverse owner-managed companies will find and build productive capital partnerships.
Inclusive thinking at Cambridge Associates recently posed a question about the effectiveness of the Rooney Rule, a policy that ensures diverse candidates in every search process. They note that best practices are evolving in the use of diverse selection committees as well. Relatability and bias are intertwined in ways that we are just discovering.
“You must be the change you wish to see in the world” Mahatma Gandhi
Congratulations & See You There
CFA Institute of New York’s first live event the evening of March 31st. Women in Alternatives. Steward’s Sheryl Mejia will be joined by Petya Nikolova of New York City’s Retirement System, Nadya Prashad of Capital Fund Management, Justin Pollack of PineBridge, Mariah Gratz of Weyland Ventures and others. 
PEWIN. Moments that Made Her. In the latest edition, Kelly Williams interviews KKR’s Alisa Wood who shares career stories that led to joining KKR decades ago. She relates that the who matters much more than the what in making career decisions. 
SEO is hosting their 13th Annual Alternative Investments Conference, AICON April 6th. This will be one of the largest and first in person event for hundreds of LPs and GPs in New York. 
What We Are Reading
Harvard Business Review. Nancy Langer and Sharon B. Heaton. To Make Deals in the Middle Market Private Equity Needs Cultural Literacy. Building transaction credibility with company founders requires specialty skills and knowledge. 
Kenan Institute Frontiers of EntrepreneurshipSeeding Smaller and Regional Funds to Increase Opportunity. Early access to capital remains highly localized. Those top-tier outside hubs continue to face capital raising challenges. Less represented and diverse managers are raising lower proportionate amounts of capital. 
Microsoft Research. Malcolm Gladwell speaking at MITOutliers: Why Some People Succeed and Some Don’t. Perseverance is important, but existing wealth is the most significant determinant of success. Unfortunately, this leaves a substantial amount of undercapitalized and underdeveloped talent. 
Kaufman Foundation Brief. Are We Back? Early-Stage Entrepreneurship Trends Two Years into the COVID Pandemic | Trends in Entrepreneurship. While entrepreneurship has recovered, the ‘opportunity share,’ those leaving a job to start an enterprise (versus starting while unemployed), is still not back to its level before the pandemic. The opportunity share dropped from 81% (2020) to 70% (2021).
JP Morgan. Guide to Alternatives. The returns of private equity remain unparalleled and with a bottom quartile that still starts at +4%, defining anti-fragile. 
Pitchbook. 2022 US Private Equity Outlook. Predicting the emergence of new GP stakes firms.
Cambridge Associates. Jasmine Richards and Carolina Gomez. Would Adoption of Policies Like the Rooney Rule by Asset Allocators Encourage Greater Diversity Among Investment Managers? Knowledge leaders acting with intention have moved past the Rooney Rule to diverse decision-makers at the table.
Kenan Institute. Robert Bushman, Gerald Cohen. ESG Measurement: A Surprisingly Complex Issue. The combined needs of stakeholder objectives are an enormous undertaking, with solutions coming in the form of Impact Accounting to fit into our financial accounting-centric world. 
About Steward
Steward Asset Management is an anchor investor to private equity teams approaching their first institutional launch.  We utilize strategic partnerships to build diversified portfolios of private equity stakes. Our lens focuses on strategies that address innovation and disruption in the healthcare, consumer, industrial and technology sectors in the US Middle Market. 
In the attractive small fund universe, funds under $1 billion, Steward’s anchor partnership approach unlocks additional return potential by seeking to generate GP participation. Steward serves as a catalyst for founders while providing support and guidance. These features are unique to the Steward program and include a focus on alignment and diversity.
Headquartered in New York City, Steward’s competitive advantages include a deep pipeline of talent, proprietary assessment tools, experience negotiating terms and extensive relationships within the emerging manager investor community. The team has an accomplished track record of deploying capital to smaller and diverse asset managers. 
437 Madison Avenue, 24th floor, New York, NY 10022 steward@stewardassetmgmt.com | 212.210.2920 main
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