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The US Energy Sector: Out of Aces
The US Energy Sector: Out of Aces
October 19, 2017

The US Energy Sector: Out of Aces makes the case that anyone looking to invest in North America’s oil and gas sector should be cautious. No longer a play on rising commodity prices, the companies that survived the collapse of 2014 are leaner and use leverage more conservatively. Discipline is the new rule.

 

  • The nimble producers that define North America’s production capabilities are setting the world’s marginal supply curve; their ability to adjust production to match prevailing prices may create a series of mini-cycles that we believe will prevent prices from rising significantly.
  • Companies that underwrote futures contracts when a barrel of oil was worth US$100 continue to face liquidity problems as their hedges roll off; more than 200 companies filed for bankruptcy between January 2015 and the first quarter of this year.
  • Although the worst of the bankruptcy wave may be behind us, it will take a few years to resolve the remaining distress.
  • To stay competitive, upstream companies are cutting costs and building rigs only where reserves are proven, infrastructure is established, and there are plenty of service companies downstream.

 

Until commodity prices increase, we believe investors should navigate the market carefully to capitalize on the few pockets of opportunity that exist. If you would like to learn more about our research on energy private equity or to inquire about investment opportunities, please contact any of us at StepStone.

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Blending the Real Estate Allocation
Blending the Real Estate Allocation
October 3, 2017

Blending the Real Estate Allocation explores the risk, returns and statistical challenges associated with the different investment formats through which commercial real estate can be accessed. Long viewed as a binary allocation decision, relatively little research has been conducted on the performance and risks of building portfolios composed of listed and private real estate. This paper attempts to fill that void.

 

  • We simulated the historical performance of blended real estate portfolios made up of fixed capital allocations to listed equity/debt and private equity/debt, and created five hypothetical portfolios, each with a varying level of exposure to commercial real estate.
  • At a 10% allocation, commercial real estate was shown to be accretive to an overall portfolio; performance at higher allocation levels is less conclusive.
  • Like other alternative investments, real estate can present statistical challenges that investors ought to be prepared for. We advise against focusing extensively on mean-variance optimization—any allocation framework should address statistical considerations such as negative skewness in the return distributions.
  • Finally, our results show that private debt (i.e., senior loans) can enhance risk-adjusted returns.

 

This paper is the first in a series on strategic asset allocation. You can expect subsequent issues over the next few quarters. If you would like to learn more our research or inquire about investment opportunities, please contact any of us at StepStone.

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Healthcare & Life Sciences: The Evolution of China’s Next Big Market
Healthcare & Life Sciences: The Evolution of China’s Next Big Market
August 10, 2017

Healthcare & Life Sciences: The Evolution of China’s Next Big Market, evaluates the demographic and political tailwinds that have converged with the region’s vibrant technology sector to create an expanding set of investment opportunities that are as compelling as they are diverse.

 

  • China is projected to age faster than any country ever; its elderly population will double in just 20 years. More importantly, China’s baby boomers have the resources to afford and command better healthcare.
  • Regulatory reforms are encouraging Chinese pharmaceutical firms to increase their R&D budgets, attracting top global talent and reversing years of brain drain. By 2020, China is projected to be the world’s largest R&D spender.
  • Like the tech boom, private equity and venture capital should have a big role to play in the healthcare market’s development; the number of local healthcare specialists we track has grown five-fold since 2010.
  • The data garnered in SPI™, our proprietary data platform, suggest that with the right strategy, savvy investors may be rewarded handsomely—investments in Chinese healthcare companies performed better than investments in all other sectors, delivering a higher MOIC and gross IRR and half the loss ratio.

 

The insights offered in this report are the result of recent investments we’ve made in Chinese healthcare funds. We hope you find them informative. If you would like to learn more about our research or current investment opportunities, please contact any of us at StepStone.

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The ID Register: A More Efficient Universal Onboarding Platform
The ID Register: A More Efficient Universal Onboarding Platform
July 13, 2017

The ID Register: A More Efficient Universal Onboarding Platform examines several initiatives that private markets have taken to reduce the cost and complexity inherent to the investor onboarding process. Standardization in financial services has been more successful when wide-spread adoption leads to greater efficiency and does not concentrate costs to any one group. More than diffusing costs, the ID Register is a powerful tool that benefits GPs and LPs alike.

 

  • LPs spend less time performing tedious tasks by creating one profile that contains enough information to comply with anti-money laundering and know-your-client regulations in several jurisdictions, and can be shared with each fund to which the LP subscribes.
  • GPs enjoy a simpler sale process and can close each subscription faster.

 

We encourage you to explore the platform and diligence materials for GPs, LPs and service providers at www.theidregister.com. If you would like to learn more about our research on fund subscriptions, please contact any of us at StepStone.

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Overall Solutions for Private Debt Investments
Overall Solutions for Private Debt Investments
May 18, 2017

Overall Solutions for Private Debt Investments provides an overview of the current private debt landscape and describes StepStone Private Debt’s approach to investing in this nascent, yet pervasive asset class.

 

  • In recent years, a tense interest rate environment has led many institutional investors to invest more of their assets in private debt.
  • While attractive returns have made first lien syndicated corporate loans particularly popular, investors are increasingly exploring other categories within private debt.

 

StepStone Private Debt offers a full range of solutions in private debt to institutional investors building customized portfolios. If you would like to learn more about our research on private debt or current investment opportunities, please feel free to contact any of us at StepStone.

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A Comprehensive Guide To Private Equity Investing
A Comprehensive Guide To Private Equity Investing
May 7, 2017

A Comprehensive Guide to Private Equity Investing is a primer on this varied and complex asset class—providing details on the risks, advantages and terms that investors ought to be familiar with.

 

  • Each of the four strategies that comprise private equity has its own nuances; choosing the right GP with the proper expertise is critical.
  • That private equity has historically outperformed public markets may help to explain why institutional investors are projected to make the asset class a more prominent part of their portfolios.

 

We hope you find this paper informative. If you would like to learn more about our research on private equity or current investment opportunities, please feel free to contact any of us at StepStone.

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Drivers of Investment Returns: Value Creation Analysis Improved
Drivers of Investment Returns: Value Creation Analysis Improved
April 2, 2017

Drivers of Investment Returns: Value Creation Analysis Improved compares the traditional method of measuring a GP’s value-add to our proprietary approach—Drivers of Investment Returns™ (“DIR”). With hundreds of managers raising funds each year, LPs need a deeper, more detailed understanding of how each GP creates value, and whether its strategy fits the market environment. DIR indicates which analyses may yield the greatest additional insight.

 

  • In the past, comparing and evaluating managers was simpler: there were fewer managers using fewer strategies; financial engineering was often enough to generate high returns.
  • As private equity matured, grew more competitive and perfected new value creation strategies, comparing managers became more complicated. The calculus for drawing these comparisons, however, did not evolve as quickly.
  • Collecting enough of the relevant data can be problematic to a rigorous value creation analysis, and traditional approaches are difficult to compare across strategies and managers; DIR and our proprietary database address these issues.

 

The purpose of this paper is to familiarize you with an analytical tool that appears in our investment memos and research reports. If you would like to learn more about our investment approach or our research on private markets, please feel free to contact us.

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Asia Venture Capital: Less Disruptive, More Additive
Asia Venture Capital: Less Disruptive, More Additive
December 2, 2016

Asia VC: Less Disruptive, More Additive, reviews the evolution of venture capital (VC) in Asia. By some measures, VC is larger in China than it is in the US. The fact that one-quarter of the world’s “unicorns” are based in China, India, and Southeast Asia reflects Asia’s growing importance within a truly global asset class. Investors would be wise to not overlook this rapidly evolving sector.

 

  • No longer the land of copycats, many Chinese start-ups have surpassed their American counterparts in scale and function. Last year, Alibaba’s sales volume was double Amazon’s; Facebook is reportedly poaching engineers from Tencent.
  • Maturing capital markets, entrepreneurs returning to China from Silicon Valley, an exploding consumer class, and favorable public policies have helped VC in China develop faster than it did in the US; key indicators suggest that it will grow even faster in India and Southeast Asia.
  • Start-ups in these latter regions are also benefiting from China’s funding and expertise. Alibaba and Tencent have invested more than US$1 billion in Indian and Singaporean start-ups.
  • The potential for rapid growth notwithstanding, pricing for start-ups in India and Southeast Asia is still modest compared to their analogues in Silicon Valley—even considering regional risks. While this reflects an inchoate VC ecosystem, it also offers an opportunity for investors looking to broaden their VC exposure. This arbitrage will ultimately close as seen in China where valuations are catching up to those in the US. India and SEA may follow the same trend.

 

We hope this report informs your long-term investment strategies. If you would like to learn more about our research on Asia or VC, or current investment opportunities, please contact any of us at StepStone.

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The Energy Sector in Crisis
The Energy Sector in Crisis
November 9, 2016

The Energy Sector in Crisis, is the first part of a two-part series on energy private equity. In Part I, we explore the role that energy specialists played in fueling the American energy surge, as well as the economic and political factors that left many managers reeling.

 

  • Robust global demand, new exploration and production technologies, strong commodity prices, and a steady stream of credit fostered America’s hydrocarbon boom.
  • Despite its capital intensity, the energy sector shined in the early 2000’s, as growth in developing economies created a spike in demand.
  • After the GFC, new technologies helped extend strong returns even in the absence of the price increases seen at the start of the century.But when oil prices plummeted in 2014, America’s energy boom came to a halt: more than 90 companies have filed for bankruptcy, fundraising for natural resource strategies is on pace to be the lowest it’s been in five years, and a TVM of 1.1x has been good enough for first quartile for recent vintages.
  • Still, between 2011 and 2015, more than US$150 billion was raised across more than 100 funds. As pressure to deploy mounts, managers will need to adjust their playbooks if they are to generate returns in the absence of the tailwinds the sector enjoyed for the past decade and a half.

 

In Part II of this special series on energy private equity, StepStone will search for clues as to how the sector might pivot at the beginning of the next energy market cycle. Expect it early next year. We hope this report informs your long-term investment strategies. If you would like to learn more about this topic or current investment opportunities, please contact any of us at StepStone.

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Brexit: Uncertainty is the Only Certainty
Brexit: Uncertainty is the Only Certainty
November 9, 2016

Brexit: Uncertainty Is The Only Certainty  reviews Britain’s decision to leave the EU, as well as the political and economic considerations in the aftermath of this historic event. For private markets investors, the current atmosphere in the UK and the EU is particularly pertinent, as private markets tend to benefit from market inefficiencies, including those created by volatility.

 

  • However, credit markets have behaved orderly, public equity markets are up (with the exception of certain areas of the listed real estate market) and large amounts of dry powder have led to deployment pressure. The combined result has been a continuation of frothy valuations for completed transactions, which has further supported existing portfolio valuations. The largest impact experience by private markets has been reduced transaction volumes across the UK and Europe as manager find their footing in today’s uncertain environment.
  • The pace of political events in much of the developed world is accelerating. If we’ve learned anything recently—aside from the inaccuracy of current polling methodologies—it is that electorates in many nations are divided, with broad discontent among working-class families in non-urban areas who support populist movements.
  • The world is watching to see if this trend toward populism continues in upcoming elections across Europe, the results of which have the potential to dramatically change the political landscape, with significant consequences for Brexit discussions.

 

StepStone believes that Europe will continue to offer private market investors ample attractive investment opportunities. The key to success will be flexible capital deployed through careful manager and asset selection. Best-in-class managers with appropriate investment strategies should allow private markets investors to avoid the treachery in Europe’s macroeconomic environment, driving value in their portfolio companies and outperformance for their investors. If you would like to learn more about this topic or current investment opportunities, please contact any of us at StepStone.

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Ordem e Progresso: Getting Brazil Back on Track
Ordem e Progresso: Getting Brazil Back on Track
October 10, 2016

Ordem e Progresso: Getting Brazil Back on Track reviews the country’s recent troubles as well as the political pitfalls that could put the fledgling economic recovery in jeopardy. Our experience on the ground, however, suggests that sweeping reforms and popular resolve will allow the Brazilian economy to persevere. For private markets investors, now is an attractive entry point to gain exposure to the compelling demographics we identified in our October 2015 research report.

 

  • The “Carwash” corruption scandal toppled the leftist regime that had been in power for over a decade, and contributed to Dilma Rousseff’s impeachment in July.
  • Although President Temer has laid out a credible path to recovery, he only has two years to effect it; the specter of Carwash and a fragmented and fickle Congress stand in his way.
  • There are signs that the economy has bottomed out—the Ibovespa has rebounded and several indicators evince a more active economy.

 

Stagflation and the worst corruption scandal in Brazil’s history should not discourage investors in private markets; the same macro indicators (e.g., attractive entry multiples) we identified in our last report on Latin America are still in place. If you would like to learn more about this topic or current investment opportunities, please contact any of us at StepStone.

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Show Me The Money: Improving Transparency in Private Equity Fees & Expenses
Show Me The Money: Improving Transparency in Private Equity Fees & Expenses
August 8, 2016

Show Me the Money: Improving Transparency in Private Equity Fees and Expenses continues our review of fees and expenses in private markets. In Part 1, we concluded that while private markets are expensive, the returns justify the costs, even when adjusting for risk. In Part 2, we find that the industry’s history of complexity and opacity justifies the increased scrutiny from investors and regulators.

 

The SEC found significant deficiencies in policies and disclosures with respect to how GPs treat ancillary fees and expenses. But, after examining hundreds of GPs, the SEC only pursued enforcement actions against eight of them, and required none to admit guilt. Beyond government intervention, LPs have several tools for reducing their fee burdens, including:

 

  • Pursuing co-investments and secondaries, or providing anchor commitments;
  • Taking chances on first-time managers and resisting the urge to accept suboptimal, yet familiar terms; and
  • Working with advisers who have insights into the latest developments on terms and conditions.

 

Agreement among LPs on what constitutes best practice for disclosures and reporting would make life easier for GPs, most of whom want to do right by their investors. If you are interested in learning more about our research or current investment opportunities please contact any of us at StepStone.

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