Chart of the Week #50: The New Exit Game (2/2)

There are several factors that influence the performance of public and private markets. Many factors – like GDP growth, interest rates, and capital markets activity – are easy to observe and measure. Others are less readily observable but often equally important – namely, investor sentiment (or “animal spirits”). Public markets showcase the power of sentiment – public share prices reflect the collective outlook on expected future performance, updated in real-time. Put simply, the public markets provide a real-time view on how market participants, voting with their capital, view the probability of future states of the world. As Benjamin Graham said, “In the short run, the market is a voting machine…”.

In private markets, it’s harder to gauge sentiment in real-time. Performance data lags public markets, forcing private market investors to look backwards to understand where we may be headed next. So how can we better understand private market sentiment and valuations in real-time? We believe there are useful proxies that can provide insight, notably intrinsic value estimates, which provide a more real-time view of private market valuations, and sentiment-driven rhetoric (a proxy for animal spirits).

In the chart below, we plot historical quarterly distribution yields (distributions as a percentage of starting NAV) against the Navega Macro Uncertainty Index, a proprietary index that measures market uncertainty via a complex model focused on future long-term GDP growth estimates. Historically, quarterly distribution yield and the Navega Macro Uncertainty Index have had an inverse relationship. Not surprisingly, when uncertainty is high, distributions tend to be low (and vice versa).

This correlation highlights the abnormality of the current environment. Over the last four quarters, uncertainty has been historically low, yet distribution yields remain at post-GFC trough levels. In fact, they are aligned with levels typically seen during periods of extreme uncertainty. Distribution yields are over 50% lower than expected based on historical, similarly benign, periods. Put simply, as we touched on last week, the current environment is distinct in that, outside of 2022, the slowdown in distributions has not coincided with an economic recession or prolonged downturn in public equity performance.

Several factors are driving this deviation, which we cover in our latest market update, but in our latest Insights piece, The New Exit Game, we dive into one less-discussed factor: the role of manager incentives. In a historically challenging fundraising environment, sponsors’ exit calculus is changing, as GPs shift from freely monetizing companies to hoarding fee-generating assets. While others in the market are predicting a significant increase in exit activity in 2025, we believe any forecast of future exit activity should consider the shift in manager incentives which could continue to suppress exit activity in the near-term.

Find the full New Exit Game piece at Katmai Labs here: https://lnkd.in/gNaFEBbE