Steward Quarterly Highlights - 4th Quarter 2021

2021 was a year of innovation and new U.S. business formation, with 1.4 million applications submitted in September alone. Pride in the ‘side hustle’ fueled the roaring twenties. Our 2022 themes were informed by entrepreneurial vigor, coupled with growing social awareness.

The re-emergence of demand strained supply chains and challenged remote teams. Within the gap between home and office systems, cybercrimes and the new NFT (non-fungible token) cyber products found traction to horrify and entertain. Compliance and regulatory bodies raced to help guide these developments.

This combination of resurgence and innovation compelled changes in the competitive placement across sectors. Successful offerings in 2021 were based on loyal relationships and collaboration. Disruptive competitive advantages have emerged from the following key drivers:

Empowered value systems impacted customers’ loyalty and brand awareness as they took a moment to step back and contemplate their ESG engagements. Capping off the year, the 26th UN Climate Change Conference of the Parties (COP26) provided direction on tangible goals for the rest of the decade.

The skillset to invest early in inefficient areas at more attractive valuations will continue to create value. Whether in traditional private assets or more novel structures such as DAOs (Decentralized Asset Organizations), the changing opportunity set identifies opportunities earlier with aligned partnerships.

In the U.S. Lower Middle Market, small buyout partnerships have been rewarded by entering when enterprise values are below $100 million, at a significant discount in earnings multiples, often half of the public market equivalents. The heightened demand for private tuck-in transactions in 2021 is expected to increase as they provide arbitrage to enhance value and expand market share. More than 70% of U.S. Middle Market deal flow in 2021 went to add-on transactions. With large buyout valuations stretched, investors will continue to benefit from being early to participate in the runway of multiple expansion.

DAOs are a new model for investors exploring early and unique assets. In 2021, ConstitutionDAO offered a live experiment in a single-purpose DAO while raising $47 million, starting from a meme and taking crowdfunding to Sotheby’s platform to bid on the U.S. Constitution. The decentralized governance of assets coupled with enabled decision-making across groups of owners is revolutionizing the way investors engage with sponsors. We believe that this has the potential to change asset allocation pie charts for decades to come, disrupting private capital markets by defining new asset types. As history has shown, not many innovations are genuinely beneficial to the end investor. Still, with credibility and the right partners, this model promises to open opportunities for investors to further diversify with a voice.

Through the next trajectory of the innovation cycle, opportunities are emerging at the intersection of industries to address the most pressing issues. Leveraging cross-sector expertise to solve these issues will command premium pricing. To illustrate this point, we highlight opportunities in cross-sector hubs where we see an unusually high level of opportune deal flow:

A working capital crunch is underway, particularly among U.S. Middle Market companies with less access to financing alternatives. Inflated energy and input costs, extended delivery schedules and increased wage pressures are a trio of culprits leading to what we expect will be a dynamic set of winners and losers in 2022. This trifecta will conspire to put investors in the driver’s seat, balancing negotiations and dampening valuation levels—which we expect will remain in an attractive range of less than 10x earnings multiples in most Lower Middle Market sub-sectors.

Until the current supply chain issues and labor market dislocations are resolved or at least mitigated, many of the 200,000 companies within the U.S. Middle Market universe will experience rolling periods of stress and therefore look to secure capital partners.

Alpha and beta measurements are tricky in the private markets, and we believe valuations are now stretched. Since earnings must catch up to drive the next leg of beta-related returns, alpha is ever more valuable. Age-old proxies used to contrast the alpha and beta of private market peers often include (i) leverage levels; (ii) sector/sub-sector definitions; (iii) sustainability of cash flow and (iv) the number of value-added levers. While market beta has driven multiple expansions, there is an increasing focus on identifying teams that bring unique expertise-driven alpha to drive unique return opportunities.

One nascent and growing area for alpha generation is the area of GP stakes, a comparatively new lever to add return from a strategic relationship. Multiple GP stake offerings—including Steward’s—have recently targeted debuting private market managers to unlock talent and empower their success as they target deals at an earlier stage. Why solely invest as an LP when you can also participate early in the GP’s success?

The rhetoric has been long during the waves of social justice and environmental risk awareness, but results have been less concrete. During this initial phase, progress has focused on hiring JEDIs (Justice Equity Diversity Inclusion officers), assessing vendors, boards and reporting to newly appointed ESG committees.

With the SEC now showing a marked interest in the claims of companies and asset managers, we expect guidance on comparable and quantitative measures. The COP26 investor alliances are at the forefront of this move to ‘measure what matters’ and achieve net-zero carbon emissions. As a result, greater clarity is expected to emerge around quantitative measurements for ESG factors in the investment processes.

As goals are set in the spectrum of ESG-aware to more acute impact, a pre-eminent focus is building on the time horizon used for the risk-return hypothesis. This is because most investors creating risk-adjusted returns with an ESG hypothesis will inevitably be both highly engaged and long-term oriented, where effectiveness can be more directly matched with sustainable outcomes. 

We want to express our heartfelt thanks to Beth Falk, the founder of Falk Marques Group, a subsidiary of With Intelligence, for hosting an inspiring Women’s Private Capital Summit. The event brought together senior-level private markets investors and allocators to discuss present opportunities. The event featured Kim Lew, CIO of Columbia Investment Management, and Catherine Ulozas of Drexel University, conversing on diligence and asset allocation strategies for 2021-22. Steward founder Sheryl Mejia was joined on stage by Novisi Atadika Nirschl of Memorial Sloan-Kettering Cancer Center, Kristi Craig of Georgetown University and Sophia Tsai of Trinity Church Wall Street.

 This month, the Bloomberg Mandates team proudly hosted their fourth annual Diversity Drives Returns event, comprising an excellent series of discussions. Pamela Hutchinson, Head of DEI for Bloomberg, commenced with an overview of the diverse talent landscape from multiple perspectives. Later in the event, Bloomberg’s Gina Martin Adams led a discussion with allocators Meredith Jones of Aon, Susan Webb of Appomattox Advisory and Sheryl Mejia of Steward.

 We are also grateful to the team at Buyouts, PartnerConnect East 2021 for coordinating one of the first live conference events in New York covering the dynamics and opportunities through the U.S. Middle Market. Anne Anquillare of PEF Services, Robert Chefitz, founder of Egis Capital Partners and Sheryl Mejia of Steward engaged in a lively discussion on “Emerging Manager Transitions: How to Navigate Transitions in the Illiquid Alternative Asset Space.” 

 We enjoyed a series of creative discussions between independent sponsors, deal makers and co-investors, hosted by ACG New York.

 Pitchbook. On the podcast: The evolution of GP stakes. 2021 is expected to set records for GP stakes deal activity, and more than $20 billion is currently being raised across GP stakes funds. Granted, the majority of those transactions will occur in the U.S. Middle Market, rather than in Europe and Asia, where the strategy is still in its infancy. Nonetheless, investors can expect more opportunities to arise for GP stakes investing across the globe in the coming years.

Pension & Investments. Private equity investors expect big results, survey finds. Of global private equity investors, 89 percent expect to earn an annualized internal rate of return of more than 11%, and 27% expect to achieve more than a 16% IRR from their portfolios over the next three to five years, according to Coller Capital’s Global Private Equity Barometer, a biannual investor survey.

Probitas. Investor Trends 2022. Probitas highlights investor preferences among sectors, fund terms, fund sizes and more. Topping the list of attractive strategies were funds in the U.S. Middle Market buyouts sphere (fund sizes of $500 million to $2.5 billion). Investors are fearful that larger buyout purchase price multiples are too high, threatening future returns.

 McKinsey Quarterly. How ALJ – a ’75-year-old start-up’ – leads with purpose. The Jameel family has deployed capital and built partnerships around the globe, being early to compelling disruptive opportunities while embracing a vision for an inclusive future.

Dana Perino, Everything Will Be Okay. On the Podcast: Regaining Faith In The American Dream, Everything Will Be Okay. David Rubenstein discusses his new book, “The American Experiment: Dialogues on a Dream,” and shares the importance of understanding civics and American history and the challenge to live up to it.

Andreesen Horwitz’s, Tarun Chitra. Building and Running a DAO: Why Governance Matters. The ability to use smart contracts to govern assets is a future beyond stock markets and funds. Many more asset types can be collectively owned while originators maintain rights of creatorship. The new decentralized model draws on current governance but draws talent from a more diverse set of actors.

United Nations. COP26 Together for our Planet. Glasgow hosted a two-week conference that moved capital markets. Its outcome—the Glasgow Climate Pact—brings together 200 countries. Representing private finance, Glasgow Financial Alliance for Net Zero includes over 450 firms that control $130 trillion in assets and require its members to set robust, science-based net-zero targets.

Masters in Business. John Doerr on Sustainable Investments. Venture capitalist John Doerr, Chairman of Kleiner Perkins and author of the recently published “Speed and Scale: An Action Plan for Solving Our Climate Crisis Now”, is interviewed by Barry Ritholtz. He shares the scale and scope of opportunities evolving in the climate positive landscape.

Marcum’s Jeffrey Weiner, Thoughts of the Week. Side Hustle Nation. Americans, freed from commuting during the worst months of the lockdowns, had spare time on their hands and saw a once-in-a-lifetime chance to take the risk to start their own business.

JP Morgan. Guide to Alternatives. Alternatives to dry powder grew to $3.3 trillion and returns in Venture Capital and Private Equity topped the asset class chart for the fourth year in a row, as of Q2 2021.

Bloomberg, Martine Paris. Ralph Lauren is Selling Digital Wares on Roblox. Apparel brand sees digital fashion as a future revenue stream. The metaverse wins over new customers to brands via NFT ownership of fashion.

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 and opportunistic strategies. 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. 

Disclaimer.

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