The bull run in the investment market over the past decade has transformed investment management from a niche occupation to a huge global industry. However, the good times never last forever. With factors like global conflicts, tightening monetary policies and cooling economic growth, the investment market is showing signs of weakness. This brings both opportunities and challenges to investment management firms. On one hand, the long bull market accumulated abundant cash reserve for investment managers to seize bargain opportunities. On the other hand, mark-down pressures and weak fundraising activities are forcing investment managers to adjust their strategies. This article will elaborate on the impacts of shifting market conditions to investment managers in aspects like valuation, capital deployment, client relations, etc. There will also be discussions on how investment managers could turn such challenges into opportunities.
Cooling fundraising activities put pressures on capital deployment pace
The funds raised by investment managers through activities like IPO and private equity fundraising have declined substantially in 2022 compared to last year, with a 50% drop globally and over 70% decline in the US. Such cooling fundraising momentum curtails the capital reserve, or dry powder, investment managers could deploy for future investments. Many institutional investors that committed large amount of capital to investment managers are now asking them to slow down the pace of capital deployment in order to preserve cash. The monthly capital deployment by global venture capital funds in May 2022 was 30% lower than the 2021 average. For investment managers, this means they need to be more selective and strategic when investing their remaining dry powder. Porfolio companies that relied heavily on endless capital infusion but have unproven business models will suffer the most. Investment managers need to focus more on companies with healthy cash reserve and clearer path to profitability.
Interlinkage between public and private market valuations
The turmoil in public equity market with major indexes dropping 20-30% is also impacting private valuations. Public market downturns reduced the valuation of institutional investors’ equity portfolio, which in turn tightens their wallet for private investment. Cross-over funds that invest in both public and private assets also facilitated the synchronization between public and private market valuations. By May 2022, 68% of venture capital funds have already marked down valuations for their private portfolio companies. For investment managers, this means the extremely high valuations common during bull markets need to be adjusted down to more reasonable levels. For investments already made at sky-high valuations, investment managers need to focus on helping portfolio companies extend cash runway and improve operational efficiency to ride out the valuation storms.
Opportunities in bear market bargains
Despite the weak sentiment and correction pressure, bear markets also provide valuable bargain-hunting opportunities for investment managers with sufficient dry powder. Good investment managers need to look beyond the current downturn and maintain a long-term perspective. They need to focus on fundamentals like addressable market size, competitiveness, profitability and growth prospects when evaluating investment opportunities. Areas like Chinese consumption, biotech and greentech continue to enjoy huge growth potential despite economic slowdown. Companies operating in these areas with strong business fundamentals but are undervalued due to irrational market pessimism present great investing opportunities. Investment managers need to follow a disciplined investment process and Strict due diligence to identify quality assets trading at a discount.
Importance of client communications and transparency
In a downturn, communications and alignment with clients become even more important for investment managers. They need to proactively communicate with clients on issues like valuation methodology, portfolio composition, risk exposure, etc. Be frank about the business challenges and uncertainties, while also highlighting positive development and growth opportunities. Explain to clients the cyclicality of the economy and avoid panic selling quality assets at a loss, which destroys long term value. Investment managers also need to align incentive structures with clients’ interests through tools like management fee discounts and performance based compensation. Investor education on topics like risk management, inflation hedging, crisis alpha generation etc also help align expectations.
The current investment market downturn provides critical test for investment managers regarding their strategic planning, valuation discipline, client communications and bargain-hunting capabilities. Companies who could adapt strategies timely, manage valuations cautiously, communicate transparently and seize mispriced opportunities in turbulent times will gain more client confidence and strengthen their brand value. When market eventually recovers, these investment managers could continue to outperform peers and deliver standout investment performance to clients.