Liquidity Priorities and Private Markets

Liquidity Priorities

The Fed continues to battle inflation by raising interest rates. We’ve had five rate rises since March 2022, from .25% to 3.25% We have two more rate hikes to go before year-end, at which point we should be at 4.5%. The Fed’s intention was to shock the system, and it’s worked for the most part in that investor sentiment is bleak, as are public asset prices across the board. We’ll talk more about the difference between public and private market prices below.

It’s prudent to plan for 18 to 24 more months of negative market reactions. Planning, in this case, refers to ensuring that you have the necessary liquidity to cover your needs, more or less, over the next few years. This is true during good times and bad – it’s worth repeating in both cases. This is the basis of our liabilities-driven risk framework, which prioritizes liquidity above all else so that you are never put in the position of forced selling. It’s prudent to take a cautious view of inflation, market prices and the Fed while we still have a lengthy list of complex challenges to face. That being said, the multiples on some of the very best public companies are now approaching their March 2020 Covid panic lows. It’s increasingly likely that many of today’s public market prices will be viewed as excellent opportunities in hindsight.

As of now, it looks like the last rate hike will be .25% on Feb 1 to bring us to 4.75%. The first-rate cut on the distant horizon appears to be Dec 2023. Just as the Fed waited too long to begin raising rates, it’s likely that the Fed will also overshoot on rate hikes. Either way, the end of the rate hiking cycle is approaching.

Structural advantages of private investments

Private market investments have the advantage of long investment lockup periods and a lack of constant in-your-face public market pricing. A relatable example of this structural advantage is home ownership. Homeowners often hold for decades and only see their home’s estimated pricing by occasionally checking Zillow or talking with a broker. When you invest in a venture capital fund or private equity fund, you often sign a contract to invest for around seven to ten years. You can sell these private assets through a secondary market, but it will often be at a discount.

The Refinitiv Venture Capital Index aims to replicate the performance of the US venture capital asset class. The index is down roughly -60% since the November peak, however, VC funds are understandably reluctant to mark their portfolios down by that much. Often they can wait to see if markets improve. Either way, the pressure is building over the next two quarters for private funds to move their valuations closer to reality.

This lack of price transparency is generally considered a positive feature for both investors and asset managers. It’s much less stressful to turn a blind eye to sharp market corrections. This example is a very loose relationship, but the publicly traded VNQ vanguard real estate index fund is down -33% this year while many real estate metrics have barely budged.

Another way to think about this is that public market prices are the price you would get if you wanted to sell immediately. If you try to sell your private market assets today, you can certainly find a buyer willing to pay 75% of what you would consider the fair value. Most would rather hold until market conditions improve. This shows us, in many ways, that a lack of market liquidity pushes daily prices lower than their perceived private market fair value.

Either way, this is why we emphasize the liabilities risk framework. Avoiding forced selling of any asset, public or private, during periods of market stress is the most important risk management tool.

iBond Interest Rates Falling

For people paying very close attention to market details, you’ve probably come across I-Bonds. These are treasury bonds linked to inflation sold by the Treasury. They have a few restrictions, like $10k maximums, for example. New issues were yielding a guaranteed 9.42% in May which will drop to 6.4% on Nov 1. This is one of many interesting indications of dropping inflation rates.

Mellon Adopts Crypto

The oldest bank in America, BNY Mellon, founded by Alexander Hamilton and Aaron Burr in 1784 has decided it will participate in crypto custody. BNY is the custodian of choice for USDC reserves, one of the leading US dollar stable coins with $50B in 1:1 assets.