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Steward Quarterly Highlights 2nd Quarter 2022

Steward Quarterly Highlights 2nd Quarter 2022
Navigating Middle Market Innovation

Managing Systematic Risks in an Era of Innovation and Disruption
Over the quarter, headlines have emphasized systematic risks, notably the shuttering of the IPO window, heightened inflation concerns and geopolitical instability. The unusual post-pandemic economy is managing many distortions at the same time. The San Francisco Fed recently reported that the primary driver of heightened inflation stem from shortfalls in supply rather than excess demand. In short, rate increases will be less helpful as a tool to bring inflation into line.
The supply chain discontinuities coincide with forces of innovation propelling secular transitions within the healthcare, consumer and industrial sectors. These additional shifts in supply and demand for raw materials and goods are further testing the pricing power of established players as well as opening windows for new entrants and niche players.  
How much do Supply and Demand Drive (US)  Inflation? Source: Adam Hale Shapiro, Federal Reserve Bank of San Francisco.
How much do Supply and Demand Drive (US) Inflation? Source: Adam Hale Shapiro, Federal Reserve Bank of San Francisco.
We expect supply rationing to spur innovation and be more effective at quelling inflation, as we normalize supply and demand dynamics. The higher costs of capital and energy prices are also adding healthy rationalizations, following years of stimulation and heightened valuations. Labor shortages, IPO disappointments, supply disruptions, higher energy prices and higher rates have rattled the confidence of many investors, jolting them into a defensive posture. 
Pressures from the supply side may ultimately reward investors allocating to smaller companies, those positioned to drive organic growth and fill niches of excess demand. We believe that this is an excellent time for Middle Market companies to capture market share and deliver outsized returns.
Through a period of inflation, equity risk-taking can be a very effective hedge if, indeed, the economy exhibits growth and avoids stagflation. Research from Deloitte recently reported that inflation accompanied by modest growth is akin to a sun shower, helping to ultimately nurture growth. Growth-led inflation can help investors and companies adapt and capture market share as they navigate disrupted-disruptor dynamics. Alternatively, without growth during an inflationary period, equities are under more significant pressure to extract additional cost savings and utilize financial hedges to mitigate risks while also differentiating and rationalizing. 
Is this a real bear market that will exert pain or just another mini-cycle?  
In the current risk-off, post-stimulus market, the immediate focus on free cashflow generation is driving valuations and capital allocations. The IPO window is nearly closed amidst a shallower appetite for innovative but not yet free-cash flowing companies. Over the next few years, as stabilization returns, the capital preservation mindset will shift to active mining for alpha, giving way for IPO leaders to regain footing and deliver on their goals.    
 A raft of technological, industrial, consumer and healthcare transitions are currently underway, while the risk-off sentiments create a lack of capital to support innovation. This imbalance provides an attractive opportunity to reward those investors leaning into the acceleration of disruption across both public and private markets.
As risk-appetites return, unproven but transformative opportunities with the ability to generate free cashflow will have another chance to demonstrate value and achieve higher multiples. In addition, many IPOs facing supply disruption challenges may find themselves re-invigorated as they prove themselves worthy disruptors.    
For smaller private companies, those in the Middle Market, that often transact at modest valuations compared to their larger peers, there has been an outsized opportunity to meet the surge in demand. They are assisted by the forces of disruptive innovation being supported by enabling adaptive robotics, artificial intelligence, novel therapies and industrial-energy transitions. We have the potential to harness this growth, avert a more profound recession and continue the trends of full employment, all of which bodes well for a mini-cycle.  
“We are in a unique time in the history of medical science. Right now, there is an incredible conjunction of chemistry, biology, cellular therapy, and artificial intelligence. The work that has been done over the past two decades in understanding the human genome is now yielding results, and the understanding of new cellular pathways to disease is a reality. Small companies and small research labs are hugely productive these days.”
­­Akram Bouchenaki, CEO of Abdul Latif Jameel Health
Sector Notes
Among the disruptive and inclusive opportunities in healthcare, technology is being integrated throughout the largest and smallest ecosystems. 
Data across populations provides effective tracking of situational information to ensure transparency to payors and identify the efficacy of treatments and side effects on a much larger scale. Precision diagnosis and wide-scale treatment distribution in acute care, on the smaller end, is bringing down costs and improving the quality of care. From accurate high-risk pregnancy identification to the ability to target specific cancer cells, significant improvements in diagnosis and care are revolutionary and accessible to more patients. 
On the cellular level, clinical trial research has also been impacted by new technologies, particularly in artificial intelligence and visualization. It is now possible to observe and analyze intra-trial cellular changes that expedite analysis and shorten the timeline for approval.                
Biotech has been at the forefront of innovation and is certainly feeling investors’ avoidance of risk. However, as appetite for risk returns, the expanding global healthcare opportunity set may be among the earliest beneficiaries.
Industrial and Technology
Supply constraints have fueled cost increases for durable goods, which are not usually one of the more volatile components of inflation. This pricing power translates to support for innovation in the Middle Market’s manufacturing, energy and construction sectors. 
Among the innovative transitions, we have recently seen small buyout capital directed towards affordable residential solar, electric vehicle components, emission-reducing industrial technologies and eco-friendly recycling of technology hardware and batteries. Many of these companies are also driving sustainable change.   
Additionally, we are at the beginning stages of improved logistics and the re-invigoration of global supply chains. These are among the most effective antidote to the supply-driven inflation pressures. Leveraging opportunities in logistics directly helps address the global backlog and acute demands in mobility, chemical manufacturing, food and raw material distribution.
“Supply factors explain about half of the difference between current 12-month PCE inflation and pre-pandemic inflation levels, and the effects appear to be rising more recently. Demand factors are responsible for about a third of the difference, and those effects appear to be diminishing more recently.” 
Adam Hale Shapiro, Vice President in the Economic Research Department of the Federal Reserve Bank of San Francisco
Future Fluency
So far, the key to navigating systematic risks in 2022, as services and products recover from the current rationalized state, involves future-proofing one’s portfolio and selecting innovators, dealmakers and opportune niches.  
For years, organic growth within larger companies has been fueled by the acquisition of innovative offerings from smaller, nimbler companies. We believe this trend will accelerate as high-growth Middle Market companies continue to serve as outsourced R&D departments for their larger ‘future’ strategic partners. 
Smaller private companies are one of the most potent forms of capitalism. Private capital partnerships between private capital providers, growth equity and small buyout teams and management teams bring sector experts together at the table to make immediate, impactful changes. Moreover, making bold decisions unrelated to quarterly profit metrics and focusing on longer-term results allows these companies to address opportune market needs. These benefits go far beyond financial results and provide enormous benefits to long-term sustainable goals at the heart of the transitions sweeping through the economy. 
At Steward, our capital has the potential to improve access to capital to support successful entrepreneurship, deploy inclusive practices and promote sustainable business practices. Unlocking talent and opportunity are at the core of our mission.         
Congratulations & Thanks
Congratulations to 17 Asset Management and Lily Jin of AIIB, who together hosted a forum centered around their joint report Inclusive Healthcare in Asia. The event connected key and influential stakeholders globally to invest in healthcare funds and businesses in Asia focused on accessibility, health literacy and equitability. 
Saxena White’s Women’s Alliance, whose leader Marisa DeMato hosted a Diversity Investing Symposium in Delray, Florida, and brought together the pension, investment and legal communities for a dynamic discussion.
Hispanic Heritage Foundation’s 9th Annual Investors Forum  conference brought together leading institutional investors and asset managers to discuss investment strategies and the 2022 investment landscape. 
What We Are Reading
Asian Infrastructure Investment Bank. How Private Equity Investments Help Financing Infrastructure for Tomorrow.The report reviews how private equity investments are uniquely positioned to achieve certain development impacts, including having more influence on the management and governance of the investees. It has the potential to drive higher standards of corporate governance and transparency. In addition, private equity creates a multiplier effect for private capital mobilization. 
 Auxilia MathematicaPrivate Equity Value Creation Analysis. Broad market forces can influence valuation levels. This seminar provides an in-depth review of measuring skill in the risk-reward profile and the market impact versus value-added initiatives.
 McKinsey. Akram Bouchenaki, CEO of Abdul Latif Jameel Health. Partnering for Health Equity. Disruptive technologies across disciplines (from new medicines and therapies to rapid advances in AI and machine learning) may offer tantalizing prospects for treating more people, more effectively, and more affordably than ever before. And yet, disparity gaps continue to widen.
Future Fluency. Melissa Paschall, Melody Meyer, and Maryanne Hancock. When Climate Enters the Boardroom. A look inside the boardroom at how boards and directors are confronting the climate crisis.
Barron’s. Jean Hynes. Healthcare Revolution Is Coming. How to Invest. The tricky part for the average investor is that we’re experiencing a revolution in biology right now. There are 50 areas of medicine that are changing, making it more complex. The opportunity set for a healthcare public investor is about 60% biopharmaceutical companies, 20% healthcare-service companies and 20% medical-technology device companies. We are overweight health-insurance companies and biopharmaceuticals and underweight medical-technology companies.
LifeSci VC. Bruce BoothIn Defense of Early Stage Biotech IPOs.   It’s a mistake to blame “too many early-stage IPOs” for the plight of the markets today. Looking at 157 therapeutic biotech IPOs that went public in 2020 thru early January 2022, if it was true…you’d see a trendline towards “better” relative returns in later-stage assets. Unfortunately, that’s not been the case.
Industrial producers or manufacturers worldwide will need to adopt new equipment, machinery and technologies, ranging from energy-efficient solutions to bio-energy and carbon capture/utilization/storage solutions by 2050. 
Middle Market Musings. Avante Capital Partner’s Jeri Harman. Episode 19The discussion is a fast-paced tour of Jeri’s early career, the impetus to create her fund, and the importance of culture in harnessing individual “superpowers.”  
New York Times. New York City Comptroller Brad Lander. Investors Deserve to Know the Climate Risks their Assets Face.    The SEC’s proposed rule mandating climate-risk disclosures offers an overdue, urgent, realistic opportunity for investors to get better estimates — and act on them — while they still matter.
Federal Reserve Bank of San FranciscoHow much do Supply and Demand Drive Inflation? The Supply chain is responsible for ½ of inflation, demand 1/3 with the balance ambiguous.
Deloitte. Four Futures for US Inflation. Scenarios for how inflation might evolve in the next three years and actions your organization can take to be resilient in each. 
MarketWatch. Steve Gelsi. They have Shattered Barriers. On Wall Street, the new biggest private equity firms are run by Black and Latino billionaires and people of color.
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. 
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