Limited partners (LPs) often depend on private-capital distributions to fund outstanding commitments, which can include other private-capital funds, benefits to plan participants and operations-related costs. In the first half of 2022, public-market volatility coincided with a notable drop in distributions across many Burgiss Manager Universe (BMU) asset classes, especially private equity and debt. While capital calls also fell to more normal levels after a busy end of 2021, it is not clear whether these asset classes are making net distributions, which could potentially create a problem for LPs with self-funding portfolios. In this blog post, we look at recent private-market cash flows and what they could mean for LPs going forward.
Mediating the life-cycle problem for a more realistic portfolio
Raw BMU data provides a simple approach to looking at cash flows: we can take the funds in an asset class and just add the distributions and contributions. Net distributions to LPs, which are critical for LPs who manage cash flows, are displayed with a black line in the following exhibit. We tend to see signs of seasonality in the data, with less cash flow activity in the first quarter (lighter bars) than the rest of the year, which is most obvious for the buyout funds.
Quarterly cash flows from BMU funds
It was challenging to evaluate the drop in cash flows in Q1 2022 because it was unclear how much of the fall was due to seasonal effects. Yet with the newly released second-quarter data, we see cause for concern in some asset classes. In particular, venture capital’s net distributions have hit a multi-decade low, and senior and distressed debt have been calling capital, on net. However, simply adding up BMU cash flows is probably not the best approach an LP could take.
The BMU uses market weights, meaning that each fund is weighted according to its fund size. Private-market vintage capitalization tends to grow over time due to an increase in both the number of funds and the fund size, creating a life-cycle problem whereby the market gets younger over time. Younger portfolios will generally produce more capital calls relative to distributions because more funds will be early in the J-curve. While this is the appropriate way to view the market, our goal in the remainder of this blog post is to disentangle changes in fund behavior — cash flows — from this demographic effect within a more realistic portfolio.
Mature portfolios offer a more reassuring picture
LPs generally have target allocations that are different from the market, even within an asset class. Portfolios often ramp up to a given size, with regular annual allocations leading to a steady state as a “mature” portfolio. We reweight the BMU to create such a portfolio — one that emulates an LP allocating USD 100 to each vintage of an asset class.[1]
The following exhibit plots the cash flows from these steady-state asset-class portfolios. Visually, the differences between the gross cash flows in the exhibits are subtle, but the net-distribution lines differ dramatically for all asset classes, except real estate. Correcting for the greening of the BMU, in which new vintages with young funds grow relative to previous vintages, a somewhat more reassuring picture for self-funding LPs appears.
Quarterly cash flows from BMU funds, reweighted for vintage
While the net distributions in the steady-state portfolios appear less dire than those in the first exhibit, we still see challenges that lie ahead for allocators. Private-equity asset classes generated growing net cash flows for LPs in recent years, but this came to an abrupt stop in the first half of 2022, when net distributions were only slightly positive.
Although private-debt net distributions were more mixed over this period, these asset classes have become net capital callers. The results are less dramatic in steady state but can still cause strains for self-funding LPs. In contrast, real assets appear to be a relative bright spot, and while net cash flows in real-asset subcategories are noisy, they have been performing reasonably well compared to recent history.
Diversification is more important than ever
BMU cash flows present an interesting view of private markets. For an LP concerned about funding commitments out of distributions, however, it is important to know that using market weights hides some crucial details. By reweighting the BMU, we provided a more useful look at the cash flows of mature asset-class portfolios. These cash flows show signs of trouble for debt portfolios, which were net capital callers in 2022.
In contrast, real assets have maintained relatively strong net distributions. Finally, private equity falls somewhere in between: net distributions were down dramatically after a spectacular 2021, but still slightly positive. With private-capital cash flows giving LPs mixed signals, it is more important than ever to maintain a diversified portfolio. Stay tuned to see how a diversified private-asset portfolio would have fared in comparison.
This blog post originally appeared on Burgiss.com. MSCI acquired The Burgiss Group, LLC in October 2023.