The Great Equity Reset

The U.S. public equity markets long served as the primary growth driver in pension and endowment portfolio asset allocation. Across market cycles, by staying the course, investor portfolios experienced meaningful capital appreciation, which funded drawdown requirements and growing retirement benefit liabilities in largely underfunded public pension plans. Today, we are in the midst of a movement in asset management - a “Great Equity Reset” - causing investors to rethink traditional asset allocation models, risk management and return assumptions.

For years, private companies entered the public markets via IPO transactions at lower valuations, accruing value and benefiting shareholders as they moved up the capitalization spectrum. Over the last two decades, venture-backed technology companies, such as Amazon, Apple, Netflix and Google, have grown to represent a disproportionately large percentage of the value of U.S. public equity indices, having matured to large-cap status after entering the public markets as small-cap stocks at the time of IPO. For example, as of August 2020, the FAANG stocks represent roughly 15% of market value of the S&P 500.

FAANG Stock Market Capitalization 2004-2020

The success and growth of such venture-backed technology companies in the public equity markets has contributed to increased awareness of venture capital funding as a mechanism for incubating innovative, market-dominating companies that can fuel U.S. and global economic growth. As technology has become ubiquitous across sectors and demonstrated its ability to drive meaningful shareholder value throughout market cycles, the investment industry has witnessed talent abandoning the public markets, as well as private equity buyout investors migrating to earlier venture and growth stage investing where technology opportunities are more pervasive.

Median Pre-Money Valuations (USD, millions)

Furthermore, the influx of capital to private markets in recent years has resulted in more frequent opportunities to take liquidity outside of public market listings. Companies have stayed private longer or foregone IPOs entirely, resulting in a sharp decline in the number of public companies, particularly with respect to the small-cap stocks. A robust secondary market has emerged, and the volume and asset value of acquisitions by strategic and financial buyers have increased.

Meanwhile, the acceleration of technology adoption catalyzed by a pandemic stricken global society has corresponded with a generally positive environment for private companies choosing to list publicly, and one that favors verticals such as automation, cloud, digital enablement and healthcare where venture equity is a frequent source of early capital. The public market’s reception of recent venture-backed technology company public offerings including Snowflake ($81b), Palantir ($56b), Asana ($23b) and JFrog ($22b), underscores the current robust IPO environment, supplementing strategic and financial buyer transactions as a source of liquidity.

Number of Venture Capital IPOs and $100M+ Financing Rounds

Capital Invested in Venture Capital IPOs and $100M+ Financing Rounds (USD, millions)

Hiding in plain sight, the venture capital equity markets have mushroomed over the last twenty years, coming into their own as the dominant driver of technological innovation, job and wealth creation and resultant GDP growth. The “Great Reset” of 2020 has, in many respects, catalyzed a long-term trend toward more venture capital investment opportunities relative to the public equity opportunity set.

This movement is not a moment passing in time, but a culmination of changes transforming the U.S. equity markets – impacting the flow of capital and influencing the decisions of fiduciaries of capital. The domino effect spurred by COVID-19 has illuminated how critical technology investment is to the health of our economy, the necessity of science and healthcare investment for humankind to survive and flourish, and the financial equity divide in our society - an equity divide that venture capital is uniquely capable of closing through access to capital, the financing of innovative technologies and life sciences, job creation and intergenerational wealth creation.

Alternative investments, such as venture capital, are complicating traditional asset allocation techniques and risk models. According to the CFA Institute, “institutional and private clients have been increasingly turning to these investments not just to supplement traditional long-only stocks and bonds but also sometimes to replace them altogether.”

Do we continue to minimize investment to venture capital due to traditional views of venture investment risk and an outdated perception of venture capital’s exclusive role as a return enhancer in the broader equity portfolio? Or do we reset and rethink our equity growth allocation and risk models?

The “Great Equity Reset” is the beginning of a movement in asset management—a rethinking of traditional models and frameworks of risk and outcomes—a movement with tentacles extending far beyond asset allocation yet tethered to the very process. The planning, implementation and execution decisions made by investment staff and committees result in actions that shape the future of the world we live in through the commitment of capital. As stewards of capital, can we afford to ignore an asset class disproportionately funding technology, science, innovation and capable of propelling long-term capital growth? While we are biased as an organization solely committed to financing the innovation economy through venture equity, one need only look at upper quartile venture capital risk-adjusted performance over the last 20 years to understand that our answer is, unequivocally, no.

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