When everyone seems to be headed in one direction, we at Social Discovery Ventures (SDV) like to take a long pause to consider what’s left behind.
Don’t get us wrong, we’re as intrigued as anyone when it comes to generative AI’s market-making potential. And the Magnificent Seven and cryptocurrencies will continue to draw their well-deserved throngs.
But it’s hard to squeeze any real value from that follow-the-crowd mentality — until you start digging deeper into some formerly bubbly sectors that the investment crowds have started to ghost.
Which makes us wonder: Is the collective market’s current mindset “right” about stay-away investments? Or is there untapped value in a few recently reliable areas that collective wisdom now suggests are heading in the wrong direction?
As a macro starting point, we see liquidity challenges on both ends of the spectrum — whether too much powder on hand or not nearly enough — as opportunities to explore.
We love a good crowd, too, but not when it comes to finding new investment opportunities and value. Here are three that the crowds may have left behind. Our market analysis of capital saturation and expected returns in several segments is pointing us to explore opportunities in these areas.
Private equity funds and/or potentially direct private equity deals
We are considering making a new commitment into private equity funds based in the U.S. because:
- Given high interest rates and increased inflation, there is likely to be a high amount of overdue exits from the VC funds. At the moment, those funds prefer to hold assets unrealized, since market conditions aren’t favorable for an exit. Meantime, the pressure from LPs for distributions is increasing.
- We have seen high volumes of dry powder in U.S. VC funds, which indicate both an overload of capital and a trend of lower returns. That means that buyout funds are an interesting investment option, since they can provide capital for the VC funds at a low valuation. This is a good entrance point for buyout right now.
- A breakdown of the dry-powder structure in the VC market shows that about 60% to 70% is accounted for by funds with a vintage year of 2021-23.
- After a big four-year surge before inflation fully sank in, global VC exit value remains below even 2018’s pre-inflation total — and at roughly the same total exit volume.
Funds with secondary strategies
We believe that secondary buyers continue to have an advantage in the current investment environment because:
- We see that around 80% of brokered secondary offerings were priced at a discount to the last round at the end of 2023 versus 20% priced at a discount to the last round in January 2022 (based on public information from secondary aggregators).
- A lack of exit avenues continues to impact firms and investors, with the median time from founding for venture-growth companies reaching a decade high.
- Secondary funds have an advantage in liquidity (there are exits in 2022, unlike other types of funds, as well as a fairly significant fund size in historical dynamics).
- This asset class has higher anticipated IRR since 2017.
Private debt/special situations in the EU
- In January, Fitch Ratings forecast that European default rates would rise significantly in 2024. This brings to the surface a large amount of anticipated defaults in the EU.
- Europe’s current geopolitical instability, rising inflation and energy prices, supply chain issues and anticipated recession are all flashing warning signs.
- Distressed debt funds typically flourish under such circumstances.
One last thought: Where we won’t go, and why
Mega-buyout PE funds currently face problems with liquidity and dry powder that match their firms’ mega sizes. Simply put, they are at a disadvantage on making new transactions compared to the general buyout segment. The concentration of dry powder in mega funds combined with the limited number of suitable investment opportunities will make deploying that capital efficiently very challenging. Smaller buyout funds will have more flexibility and agility.