Regime Changes, NAV Loans, and the Private Equity Storm

We’re back.

After an (unscheduled) hiatus of a few weeks, things are returning to normal.  That means you’ll get a set of these curated readings (along with a little commentary) every two weeks.  In addition, occasional original pieces will look at the investment world in new ways.

If you find this compilation of value, please consider subscribing to receive it in your inbox.  (It’s free.)

And now, on to the readings.

Regime changes

Usually, transitions to new presidential administrations in the United States are not referred to as “regime changes,” but the phrase seems appropriate this time around.  Across a wide swath of foreign and domestic policies, the old order, that which has been in place for decades, is being torn up in a hurry.

That is certainly evident on the economic front.  While investors generally expected the Trump 2.0 policies to be market friendly, the severity and inconsistency of his tariff proposals have upended prices and brought into question the dominant narrative of recent times, that of “American exceptionalism.”

While that idea went well beyond the investment sphere, it was used as justification for the outsized weighting of American companies in global market indexes.  And it was the theme of many positive strategist reports in late 2024.  Now the debate has morphed into whether this is a time to “sell America,” whether the unwinding of that notion of exceptionalism will be particularly painful.

The abrupt changes in policy have led to abrupt changes in the tone and content of the writings that are fodder for the Fortnightly.  Investment organizations are trying to find their footing in their portfolios and their communications.  Given the volume of material being produced, this could be a very long section, but here are just a few links of interest.

The reaction to the president’s trade war from most investment professionals, even those who are fans of his, has been harsh.  Although the actual policy has been a moving target, to most the economic outlook includes headwinds from all directions, as represented in a graphic from Apollo.

In April, Joe Wiggins reflected back on a December piece he had written in which he was cautious about the exceptionalism narrative:

A heady mix of overconfidence in our ability to predict an always-uncertain world, stellar past performance, and expensive valuations is always a reason to worry.  At the time, the overwhelming consensus was that the US economy and stock market could only ever outperform others.  Writing that piece felt a little heretical.

He then delves into the conviction in that thesis as an example of the behavioral traps that accompany such near-universal beliefs.

In the immediate aftermath of “Liberation Day,” Owen Lamont posed an important question:  “Buy-the-dip or buy-the-bottomless-pit?”  As they have before, retail investors responded by buying the dip, which has so far worked out, but that’s a short-term conclusion.  Is there still a bottomless pit ahead?

Ultimately, at least as it concerns equities, the path of earnings (and whether a recession occurs) will be determinative.  Already companies are pulling guidance or providing multiple forecasts for different tariff scenarios.  Items from Rothschild and Apollo provide some context; when earnings expectations get slashed, stocks suffer.

We have already seen a shift out of the dominant regime of the last forty-plus years, which featured declining inflation and interest rates.  A tariff war that throws the globalization trends that supported it into reverse could have profound consequences.

Grant’s Interest Rate Observer (no link available) argued recently that  “the risk for investors today isn’t that this time will be different, but, rather, a mean reversion to the longer-term historical record.”  Meaning, a more wicked environment than the one to which we have become accustomed.  Expect the unexpected.

NAV loans

Given the increased use of net-asset-value loans by private asset general partners, here are a couple of reports that are of interest:

~ “NAV Loans: How They Are Used and What LPs Need to Know About Them,” Callan.  This provides a good overview of the financing strategy and its effects on limited partners.

Cynicism is warranted when GPs tap NAV loans to make synthetic distributions or game distributions to paid-in capital (DPI) before a new fundraise, but when appropriately used NAV financings can be an effective tool for capital structuring or portfolio support accretive to all constituencies.

~ “NAV or Never,” Felicitas Global Partners.  Subtitled “Modeling LP returns with or without an NAV loans,” it quantifies different possible scenarios.  Also:

Debt is often conveniently hidden from LPs when General Partners (“GPs”) opt to lever at the company-level, and it is in our view, one of the main reasons why there is so much controversy around NAV Loans:  debt is now plainly visible to investors.

Private equity storm

The news that Yale is planning to sell some of its buyout funds on the secondary market came as a surprise to asset owners who have followed that institution into ever-higher holdings of alternative investments.

A report by Anne Duggan of TIFF on the possibilities involved included the above chart, which shows Yale’s allocation to private assets over the last few years.  While the university has gone out of its way to say it isn’t giving up on private equity, TIFF sees it as a “canary,” out in front of the actions likely to be taken by other asset owners.

A Wall Street Journal headline proclaimed, “Private Equity World Engulfed by Perfect Storm.”  Given the dearth of PE exits, secondary sales had already picked up significantly before the Yale announcement.  In addition, according to the Financial Times, asset owners are borrowing a tactic from PE firms and using their own versions of the NAV loans discussed above.

Ted Seides crafted an opinion piece on the changing environment, “Private Equity Investing in 2030.”  He enumerates “cracks in the old playbook” and puts forth an essential question of investment beliefs:

What private equity strategy generates the highest returns:  ownership of great businesses that compound over time or ownership of businesses where sponsors buy, make improvements, and sell?

Culture

Grant McCracken asked ChatGPT “to contemplate why it is the investment world is not better at thinking about culture.”  The output does a good job of summarizing the divide that leads investors to underestimate the power of culture in the success or failure of organizations.

Convergence

Matt Levine on traditional investment firms marketing public-private products:

A dumber, more cynical version of the story might be:  Financial intermediaries get paid a lot more for managing private assets than they do for managing public assets, so they prefer private assets.

Other reads

“Hippocrates Grieved,” William Kelly, CAIA Association.

If we were a profession, would we . . .

“Time for lenders to insist on more protection in finance deals,” Sabrina Fox, Financial Times.  Will the current environment lead to tighter covenants (finally)?

“Death of the Solo Fund Manager,” Shahrukh Khan, Cash and Carried.

I wonder if the key person problem could be framed as the “existential” element of operational due diligence in the world of capital raising.

“Can Generative AI Disrupt Post-Earnings Announcement Drift (PEAD)?” Toghrul Aghbabali, Enterprising Investor.  According to the author, “old strategies may fade . . . new inefficiencies may emerge . . . and human insight still matters.”

“Valuation Policies Are A Mess,” Seth Levine, VCAdventure.

I recently helped a fund with their valuation policy, and we asked several of their LPs for a “best-in-class” valuation policy.  No one could come up with one.

We’re not closer to reporting the exact “value” of our portfolios . . . we’re further from it than ever.

“A GP’s Family of Funds — Product Proliferation Musings,” Anthony Hagan, Freedomization.  What are the issues for limited partners when managers scale up and get more complex?

“Navigating Potential Pitfalls in ‘Semi-liquid’ Private Equity,” Julien Barral and Anna Morrison, bfinance.  On dealing with the “round” peg of unlisted asset and the “square hole” of liquidity.

“What New Sorcery Is This?” Jeffrey Ptak, Basis Pointing.

By these [interval] funds’ own reckoning, they invest in hard-to-value securities . . . And yet those holdings virtually never change value?  Ever?

”Oaktree Co-CEO Sees Private Credit Trades as Low as 50 Cents,” Sonali Basak, Bloomberg.  Are there early warning signs in the hottest asset category of late?

“The Two Most Dangerous Words in Investing.” Joe Wiggins, Behavioural Investment.

The problem with the words “always” and “never” in an investing context is that they suggest a certainty that simply does not exist in the complex and chaotic world of financial markets.

“Online/Offline Complementarity,” Byrne Hobart, Capital Gains.  Why the move to remote work strengthened rather than weakened existing hubs of in-person industry activity.

The search for rationality

“Show me a man who thinks he’s objective and I’ll show you a man who’s deceiving himself.” — Henry Luce.

Flashback: Baby Berkshire

Although he had been in control of Berkshire Hathaway for more than a decade at that point, Warren Buffett’s 1977 shareholder letter is the first one included on the firm’s website.

It includes historical perspective on Berkshire’s declining textile business and the rise of its insurance operations (and the equity securities it purchased with the float).  You can see what we have come to understand as the Buffett philosophy throughout the document, including this paragraph:

We select our marketable equity securities in much the same way we would evaluate a business for acquisition in its entirety.  We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price.  We ordinarily make no attempt to buy equities for anticipated favorable stock price behavior in the short term.  In fact, if their business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price.

With Buffett’s impending retirement, there will be much speculation about what will happen to the company that he built.  By believing in a simple vision and eschewing much of the standard business and investment playbook of the times, he created an unparalleled legacy.

(Within a few hours after Buffett’s announcement, Jason Zweig had written a wonderful summary of his life’s work.)

Postings

All of the postings can be found in the archives.

See, for example, “What Will Define the Portfolios of Tomorrow?”  That 2022 posting examined two papers about future portfolio construction.

Three years later, the ideas posed are still worth pondering.

Thanks for reading.  Many happy total returns.