Portage Partners

The denominator effect is leading to an acceleration of non-economic selling in private equity. We’re focused on strategies where there’s an attractive entry point via a substantial discount, interim cash yield, and strong fundamentals in overlooked corners of the market. The resulting risk/return asymmetry reflects a compelling arbitrage opportunity.? ? Learn more about how we’re playing this theme here:?www.10east.com ?

Over the past several decades, private equity returns have been disproportionately driven by leverage and multiple expansion. Today, these markets are fundamentally different—more robust, more competitive, and thus, relatively more efficient. Looking forward, we expect to see a transition where performance is likely to be much more driven by value creation (specialization, hands-on execution, etc.).

In private markets, adverse selection is pretty hard to prove out, but, of course, manifests itself in poor performance over time. ? We thought VC crowdfunding platforms might be an interesting case study given their proliferation since the JOBS Act and broader promise to ‘democratize’ VC. ? VC crowdfunding platforms often market ‘0% management fees’ to their investors, charge the startups a placement fee, and don’t release platform level performance data of their track record. As such, these platforms are generally incented to solve for volume, not quality. ? Stating the obvious here, but disruptive startups with talented teams, when faced with the decision to (i) pay to raise money vs. (ii) partner up with a reputable, value-add brand, are going to choose the latter over the former. ?? We partnered up with our friends at Vested to sift through the data. Unsurprisingly, crowdfunded startups materially underperformed their peers with more traditional VC backing. Only ~6.8% of equity crowdfunded startups go on to raise a Series A-sized round of any kind relative to 21.8% with the traditional VC path (more below). In total, we estimate >$1.7 billion (and counting) in individual investor capital has been exposed to adverse selection via VC crowdfunding platforms... ? What’s the takeaway? ? To quote the legendary investor Charlie Munger…"[i]f you have a dumb incentive system, you get dumb outcomes." Read the full piece here ??: https://lnkd.in/eacAEu-Z

The U.S. government (the largest customer in the world) is expected to allocate approximately $10.5 trillion* across its local, state, and federal arms in 2024. Evolving priorities that shape this enormous expenditure will create both winners and losers of for-profit organizations and their financial backers. Success in the GovTech/Services segment, we believe, hinges on aligning with durable, investible spending trends such as cloud computing migration and addressing workforce aging. Agencies are routinely pigeonholed into allocating 80% of their IT budgets to maintaining existing, antiquated IT infrastructure*–and the U.S. federal government is facing a growing skill gap in IT and cybersecurity with retirement-age workers now outnumbering employees under 30 by more than two-to-one*. Our abridged sector thesis lays out our conviction that focused exposure in the GovTech/Services segment is worthy of an addition to our private markets portfolio. Read more here ??: https://lnkd.in/eacAEu-Z *Sources available in full blog post via the above link.

What’s a major underappreciated risk in private markets investing? Partner break-ups. Key partner relationship duration is a heuristic that we use in our underwriting to de-risk the potential talent leakage, lack of focus, and resource drain that might arise from potential corporate break-ups. It’s estimated that 65% of startups fail due to founder conflict, according to Noam Wasserman, author of The Founder's Dilemmas. Irrespective of the asset class exposure, investors should understand partner dynamics and how they might complement and/or conflict with other key leaders at the firm. More here ??: 10east.com

Here's a sneak peek into our current vertical-specific focus in advance of our Market Outlook for 2024: Private Equity –?target return >25%. Focus on niche lower-middle market strategies with specialized execution capabilities in lesser competitive markets. Emphasis on sectors with cyclical insulation (i.e., mission critical services). Larger-scale funds with considerable capital deployment in 2020-2022 vintages may reel from lagged valuation marks.?? ? Private Credit –?target return >12%. Focus on differentiated exposures, senior in capital stack, backed by hard assets with positive cash flow. Crowding-in of private credit may dilute returns following the past decade’s yield famine.? ? Venture Capital –?target return >30%. Focus on seed/pre-seed and one-off exposures. Generally, expect TVPI to gradually mean revert—excessive capital deployment at market peak in 2021 has led to poor vintage diversification. Zombie companies = Zombie VCs.?? ? Real Estate –?target return >20%. Focus on residential and special situations with a healthy?unleveraged yield. Select distressed pockets are also attractive. The ‘when rates go down’ narrative is hope, not a strategy—avoid exposures underpinned by this bet.? As an aside, investors should not underestimate the resource drain of underperforming investments—it’s critical to assess the impact of legacy assets on the investment partner’s go-forward strategy.?? What sectors/sub-sectors pique your interest??

Adverse selection and fraud are mammoth risks that lurk in the often opaque underbelly of private markets. Investors should be thoughtful about their access point to these markets. Here are a few questions that may be helpful in guiding your approach: - Are interests aligned??Who is getting paid and for what? Is the investment partner paying to market the deal (poor quality signal)? Are the key principals investing their own capital in the offering? - Why am I seeing this deal??Identify why the investment partner is raising capital through your access point, is it because large-scale institutional investors passed? - Who is negotiating terms??Is the individual or team responsible for negotiating/reviewing key terms sophisticated and well-positioned to identify key risks? - Who is monitoring this deal post-close??Is there a team in-place, or resources dedicated to monitoring performance and engaging with the underlying investment partner? - Who is driving this investment decision??Are the principals responsible for sourcing/signing-off on the investment experienced? What is their prior track record? - Does the access channel have a track record??If not, why? How will they be held accountable? - What was the due diligence process and who conducted it? Investing is not best done as a hobby. Map out the incentives and be mindful of these risks. More here ?? : www.10east.com

In private equity, we generally target >20% returns. We do this by focusing resources on niche, off-the-run exposures where we believe there’s significant potential for value creation—which we reference as a Value Creation Premium (VCP). Theoretically, your expected return on private market exposures can be decomposed into a few key elements: (1) market beta, (2) illiquidity premium, and (3) VCP. Key drivers of the VCP: i)?Specialization: having a depth of knowledge where others don’t; ii) Information Advantages: knowing what others don’t; iii) Adept Execution: creating structures and executing where others can’t; iv) Sourcing/Access: seeing and gaining access to ‘first look’ deal flow; vi) Selection: time-tested filtering heuristics and/or due diligence processes; vii) Network: ability to tap specialized knowledge or augment access. Larger-scale, blue-chip exposures (think mega funds) are likely to have lower performance dispersion and cluster around the median. The markets that these players are in generally have much greater efficiency, more competition, a smaller investment universe, and often a higher correlation to market beta. The opposite is typically true for niche, smaller-scale (sub-scale) exposures—higher performance dispersion, less efficiency, and much more ‘low hanging fruit’—often creating greater opportunity for excess return. That’s not to necessarily imply that blue-chip exposures are?inferior?relative to sub-scale, it simply underscores different risk/return dynamics. A well-balanced portfolio may benefit from both. More here ??: 10east.co

Investors have an instinctive draw towards negotiating fees. But when is this focus misguided? In this piece we discuss fees, the value creation premium (VCP), and decompose risk/return dynamics for blue-chip, large-scale exposures vs. more niche, smaller-scale exposures.