Presentation

Jocelyn Lewis

Hello, and welcome back to Private Markets 360, S&P Global's podcast dedicated to enlightening and educating our listeners about the world of private markets from vast vantage points. Your Private Markets 360 cohosts both sit within Market Intelligence. I'll start off with introductions. I'm Jocelyn Lewis, Head of Private Debt Commercial Strategy.

Chris Sparenberg

And I'm Jocelyn's cohost, Chris Sparenberg, Head of Private Markets Commercial Strategy. I'm a super fan of our corner of the investment industry. My background includes time at Cambridge Associates on the portfolio monitoring and benchmarking team as well as roles in go-to-market in firms like eVestment Nasdaq and Juniper Square.

I'm excited to be joining the podcast. We're thrilled to bring our listeners exciting guests every month for discussions about industry trends and other topics of interest here on the podcast.

Jocelyn Lewis

We sure are, Chris. And if you're interested in regular private markets content, hits subscribe and tune in. Ready to introduce our guest, Chris?

Chris Sparenberg

Let's do it. Private markets is the fastest growing asset class in the financial industry, but it's also the most opaque. The Private Markets 360 podcast is focused on shining a light on the parts of the industry that drive returns and help put performance in context.

Today, we have an excellent guest to guide us through that journey. We're joined by Jad Stella, Senior Director of Private Investments at Cambridge Associates for a conversation about the Cambridge Associates benchmarks and their use across the industry. Welcome, Jad.

Jad Stella

Thank you, Chris, and thank you, Jocelyn. I'm very happy to be here today. I really appreciate you both having me on.

Chris Sparenberg

Great. Well, we're thrilled to have you here. And we'd like to start by giving you some space to more formally introduce yourself, talk a bit about your role and share some background with us on the Cambridge Associates family of benchmarks.

Jad Stella

Absolutely. Yes, happy to do that. I'm a longtime member of Cambridge Associates. I have a kind of a specialized role here at CA, where I'm not on one of the investment teams that works to build the portfolios for our clients. My background is almost exclusively in our private investments performance data.

And a large part of my role is to operate as a subject matter expert on the data set. So as part of this, I'll work with our participating fund managers, I use that term interchangeably with GPs, in, the area of participation. I work a lot with our clients, the same fund managers and others in the industry, on access to the data, understanding and application of the Cambridge benchmarks, et cetera. So that's a large part of my day to day.

And as a part of this role, I also manage the many strategic relationships and partnerships that Cambridge has around the private investment benchmarks. And so I thought -- I think you had mentioned there a little bit of background on the data set itself. For those listening who may not know, Cambridge has been collecting this private investment performance data for decades.

We've been reporting to the industry for nearly 30 years, and we source the data directly from the private investment fund managers. They contribute their data to the anonymous benchmark sample across all strategies and geographies. And important to note, it's all institutional quality data, meaning it's comprised of funds that really are a viable opportunity for institutional investors such as endowments and foundations, public pension and sovereign wealth funds, large private family offices, et cetera, where they can mingle their money, their commitments as limited partners and funds run by a GP.

And so that's what the data set is. It's these funds where LPs are institutional, they're the investors. And we really want the data set to be pure in that sense to represent the opportunity set for our clients.

Jocelyn Lewis

Wow, that was great. Jad. How do you find time to do anything else outside of work with this so many remits that you have?

Jad Stella

Yes, it's a different role within Cambridge. I think as Chris knows; I started my time here at Cambridge actually entering in the data myself. So I have a very long history, I won't say how long because then I'll give my age, but a very long history in how the data collection works and have spoken throughout the years with many of the folks that use the data on the client side, those who are using to assess the portfolios or building the portfolios for our clients, others in the industry that kind of use the data on different platforms, et cetera.

So it's been a good kind of experience that I've had with the data set. And I'm fortunate that Cambridge happens to be one of the few that has a data set that reports on kind of rapidly growing part of the industry, so.

Question and Answer

Jocelyn Lewis

Yes, it definitely does. I feel like, especially from all that background that you provided, which was fantastic, Cambridge is really a pioneer when it comes to benchmarks. So we're really excited to chat with you. Can you start off a little by telling us more about how benchmarks are used across the industry?

Jad Stella

Absolutely. First and foremost, as I mentioned, we, at Cambridge, use this data ourselves as private investments -- investor, kind of one of the leaders in the industry. So the database was initially built for us to use when benchmarking our institutional investor clients private portfolio. Some of our very first clients were amongst the first investors in, and back then it was really just venture capital, maybe buyouts. So we wanted to just have a data set that we could use to report back for our clients how they're doing in their portfolios.

We also use it when underwriting prospective new managers and opportunities. And today, we still do that. The data set has grown quite significantly. Certainly, we can talk about that. And we will use the data also when authoring the topical research pieces for the industry, present at conferences, we'll write papers for our clients from a more broad general distribution.

So that's -- first and foremost, just want to mention, we are, in our view, kind of the #1 user of the data set. And then we also make the information available to the industry. And I see to that lens, the industry using the data in many ways. Similarly, someone's going to use the returns, the IRRs, the multiples on invested capital that we produce to benchmark a portfolio of existing private investments.

They're rather going to a benchmark -- their individual fund investments, co-investments, maybe even a direct investment, et cetera, I guess, the Cambridge benchmark data, they may use the data to create a custom benchmark at some portfolio or the total private portfolio level that can be used as a policy benchmark for compensation or maybe just play and performance assessment of their own portfolio. So they'll do that.

The industry will use the data. They use the returns while performing diligence on potential new investments. They're using strategic benchmarking exercises. The benchmarks are based upon the cash flows from the underlying funds and users will use that to create pacing models to try to plan out when capital is likely called from their GPs so they can try to kind of get everything in order in that regard.

And just overall, a high level, the Cambridge US PE and VC benchmarks and others have been used for many years just as a judge, kind of a sense of how the industry is doing. There are a ton of new sources out there for it. So those are some of the ways I see -- the most part of the ways, I should say, of the data being used in the industry.

Jocelyn Lewis

So many different use cases, and there's also so many more groups that are using these benchmarks and really relying on them today, too. When I think of benchmarks, like the two that really mainly come to mind are IRR and multiple of invested capital. Other than those, what are the most common metrics in the Cambridge data set?

Jad Stella

That's a good question. I mean, I think -- if anyone listening is new to assessing private performance, kind of the first piece of advice would be to piggyback back exactly on what you said, Jocelyn, is think about the IRR. Private investments are different from public investments where kind of time way of returns are the most commonly used. But with private investments, you really want to focus in on the ability for your investments, your fund managers, to take your capital, which you've locked up in their funds and return your investment in a timely manner.

No one thinks of private investments as being kind of a quick in-and-out type of asset class. Obviously, it is a long-term commitment. But when you want to assess the performance in terms of performance return, the IRR, certainly, what you would look at. I think another guide point to you, offer, would be to use the IRRs in conjunction with a multiple of invested capital.

So as you mentioned, like a total value to pay a multiple or a distribution to pay the multiple. Here, it helps to put the IRR in context. I'm thinking about the prevalence of fund subscription lines of credit, et cetera, things that might tweak an IRR or kind of might juice an IRR a little bit, the more I observe that. The multiples of investing capital are key. Those are certainly probably the two most common metrics that are used.

Benchmarking is an interesting exercise., we've always found it. Because there's really no single one right measure, that's your silver bullet, and you're going to look at that in the quarter, and that's going to determine how well you've done. We, at Cambridge, have developed what we think is a reasonable framework that would be our "best practice" to measure your success in the private investments across a series of key metrics.

So the goal here is to measure out or underperformance, one, in terms of your scale of selecting managers. So here, what you do is you would use quartile breakpoints to rank your investment in terms of both IRR multiple against a sample of same vintage year strategy funds. So that's what we do in the performance report that we'd provide to our own clients.

Number two, we also think it's important to kind of assess your scale in selecting the right strategies at the right times. And here, one might create a custom benchmark that represents a what-if scenario. We had invested in vintage year that we skipped. If we had invested in geographies or strategies that we did not invest in, what would our return look like? I mean, you're still kind of looking at IRRs and multiples in the case of a custom benchmark.

But another kind of lens that one would take to look at your portfolio would be your performance versus a public investment alternative. And so, here -- I mean, you could certainly look at your performance against the S&P 500. You could look at it against the Nasdaq, et cetera. But you're kind of comparing apples to oranges when you're doing that because you have IRR-based returns against time-weighted returns.

So this is where we would introduce PME, which I think has certainly gained popularity in more recent years, I suppose. To answer the question, if we had instead invested the dollars that we had invested in privates to any given public market, what would the performance look like?

And then in a way, answering the question, was investing in these private investments worth it, vis-à-vis, the public alternative. So that's certainly another metric that we would use to answer questions when you're looking at yourself in the mirror and asking yourself how low your performance is on the credit side?

Jocelyn Lewis

So it would kind of then differ by use case because if I was trying to benchmark like you mentioned, to compare how I was performing against public markets using that PME would be one way. But if I had a use case where I wanted to look at how I differed against other managers that were in the same strategy, investing in the same vintage year or maybe a few years before or after, then that would be a different use case.

So then maybe I would use a different metric or technique. Is that something that you kind of, in your role, do you talk with clients about what to use based on the result that they're looking to achieve?

Jad Stella

Yes, absolutely. Number one, agree with the use cases. And we think of it as asking yourself different questions, how have I performed versus public? How have I done at selecting managers? How I've done at determining the composition of my portfolio in terms of broad kind of criteria. With clients and with those that use the data in the industry, our advice is always really try to triangulate and answer as many of the different questions as you can or when you're kind of taking a step back and performing a benchmarking exercise or something to that effect.

Jocelyn Lewis

And is there kind of one driver of return differentiation between strategies? I mean, one of them that comes to mind is just time. That's generally where -- when I think about a liquid market versus a private market. What are some of the other drivers of return differentiation?

Jad Stella

Sure. When you're talking about return differentiation that you're thinking about between the different strategies within private sort of venture versus a buyout, that type of thing?

Jocelyn Lewis

Yes, exactly. Because how I think of it is if you are going to hold a position longer then kind of the longer you're going to hold it, you're going to have a different result than maybe someone that was just providing more of a kind of quick or like a bridge type of investment.

Jad Stella

Sure. Yes. So I would say, within the Cambridge private benchmark, we certainly track funds across different strategies. If you think of venture capital, buyout, private credit, growth equity, real assets, real estate, et cetera. By and large, when I started working with this data many years ago, if the rule of thumb was, as an investor, you're going to lock up your capital for 10 years.

And you're committing your money with the GP and they're going to have control over how that gets invested and kind of has control over the return back to you as an investor, which again is why the IRR is such a crucial tool to measure the performance. I would say, in my experience, regardless of the strategy, the kind of hold period is fairly consistent.

We've seen over the years, again, it used to be 10 years as a rule of thumb in terms of how long the fund's life would be. It's expanding now -- has been just -- or holding on to their assets to really try to find the best liquidation or realization opportunity. So funds will execute extensions and they'll be -- 15 years, et cetera. So in terms of differentiation between strategies, I'd say that most private investment funds are similar, 10-plus years.

One exception that comes to mind would be private credit funds tend to hold the portfolios a little bit of a shorter time period, maybe 6, 7, 8 year time period. When I think about what could drive differentiation of returns between the different private strategies, Jocelyn. I think about risk return. So, for example, when you have venture capital would have by and large, an opportunity for the greatest outsized returns versus publics or even other PI strategies.

The opportunity to really generate an outsized return is certainly there for venture capital, but you're taking more risk. This is evidenced by spreads we've seen between the best performing funds and even the median. It's a very large spread for venture versus buyout versus other strategies. You're going to certainly have a higher percentage of your investments that we're going to lose capital.

So capital loss ratio is going to be higher for venture capital, but you're also taking more risk for more reward. As you kind of go across the spectrum of different strategies, buyouts will certainly have less risk in terms of that capital loss of their portfolio companies. Mega buyout funds tend to have a tighter dispersion of returns and they can offer the ability perhaps to put more capital to work with less downside.

Growth equity, I think, is very intriguing, mix of venture and buyout where you have both the upside return potential of the VC, but the reduced risk of a buyout. So perhaps, best of both worlds there. Another asset class that's very popular right now and it's garnering a lot of interest amongst investors is private credit. And within private credit, there are a range of strategies that are run from return maximizing strategies, like credit opportunities to stress corporate credit to more of a capital preservation strategy like a sub-cap, mezzanine, direct lending, et cetera.

And the return maximizing strategies are going to have a higher risk return profile than the other private credit funds, but still not as high as other private craft strategies. And the capital preservation strategies are going to provide investors with more muted returns, but they're more predictable and they offer more downside protection.

So in other words, you get to set a floor on your potential returns, you'll get a contract to get return, interest payments, et cetera, things like that are appealing to a lot of investors like a public pension fund that's going to need kind of a more predictable income stream, distributions from their investments, et cetera.

So it's a long-winded way of saying that these different strategies, we feel play different roles in the portfolio. And any investors' portfolio -- investors can have different needs. As an investor, you need to know what your objectives are for your portfolio and then you allocate to these different strategies with the understanding that you're going to have a dispersion of returns. But each of these asset classes, as soon as you choose to invest in them, is going to play a different role in your portfolio. Does that kind of get your question?

Jocelyn Lewis

Yes, definitely. I think framing it around a risk-return spectrum is really helpful to try and just think about all the different return potentials, and then how do you bifurcate them and figure out where you're going to get -- or what your expectations are going to be based on the type of strategy that you're pursuing.

Jad Stella

Yes. Another thought there, too, just going back to your original question around kind of the whole period or how long you're going to be investing in private is the secondary funds. There's also a range of strategies there, but they're intriguing to investors who want to invest in private investments. For those who might not want to lock up their capital for so long because you're buying into the investments where perhaps another LP has purchased a primary stake.

You're kind of picking up their ownership of a fund or a group of funds. Secondary funds can also offer some appealing kind of intriguing options there as well.

Jocelyn Lewis

They definitely can. Investing in secondary is, especially if it's just -- you see the potential, but you realize that time is not on your side. So secondaries, I think, are a good path to create some liquidity, too, and then for others to generate some more outsized returns.

Jad Stella

Yes, absolutely. Absolutely. Yes. And there are investors who are -- just feel more comfortable getting it a little bit later in the J curve. They want to avoid that kind of blind pool effect when you invest from a -- whatever fund at the beginning, you don't really know exactly how the portfolio is going to shape up. But if you can come in a little later, you have a better sense of that, just some other reasons that it's another option for investors to consider.

Chris Sparenberg

Jad, you touched on one important trend that we're seeing as well throughout 2023, really with the rise of private credit. Can you take us through any other trends you're observing in private markets, vis-à-vis, Cambridge's benchmarks and the analysis that you're doing?

Jad Stella

Sure. I mean, not so much on the rise of different strategies and asset classes and private credit is certainly garnering a lot of attention nowadays. Personally, I'm keeping an eye on the performance trends coming out of the COVID-19 period in mid-2020 through 2021, that was kind of marked by some considerable fundraising and investment. We're entering into a transitional period for privates.

Starting in 2022, a lot of things going on, geopolitical issues, high inflation, rising interest rates, issue in banking, et cetera. I think, the Cambridge's viewpoint is we're seeing a return to have normalcy and a lot of unrealized valuations for PI funds kind of coming down from that COVID-19 period. And looking at the benchmarks, the global venture and growth equity benchmarks in terms of their 1 quarter returns trailing 1 quarter, they've been negative throughout 2022.

Four straight quarters, both of them, which, I guess, more a -- totally speaking, it's been quite a while since that happened. And so really keeping an eye on how these returns will shake out, a little bit of [ smaller ] the Q1 2023 returns that are going to be produced later this month are looking flattish right now. So it's going to be very interesting to see how those progress.

It sits kind of at the bottom. Those who are familiar with private investor performance versus public markets will recognize that PI compared to publics tends to demonstrate a muted volatility, a smoothing of returns over time. So they might follow holding the markets in certain regards, but again, are a little bit more smoother and less volatile.

So interesting to see how kind of that all shakes out. With respect to the valuations coming down, recent PE and VC vintage years that we're investing at the height of COVID, so think of vintage years 2017, '18, '19, '20 have been coming down significantly. And the returns for those vintage years, their -- since inception returns are anywhere between 1,600 -- or 2,000 basis points less than they were at the end of 2021.

So -- I mean, these are so young vintage years, young funds, but it's just kind of interesting to see with starting out with such high valuations the kind of return to normalcy. And at the end of the day, again, there's still a lot of time, but it will be interesting for me to see at least how they would compare to like a 2007, 2008, et cetera. Different period of time, obviously, but it would be interesting to see how this period compares to that time period.

Chris Sparenberg

It sounds like we could be seeing, through the Cambridge benchmarks, the impact of things like down rounds in VC or manager markdowns at the very least within PE and other parts of private markets.

Jad Stella

Yes. We get the question a lot, it's like, obviously, private markets and managers have certainly some level of discretion in their marks, that type of thing. And questions we'll ask, yes we're seeing the VC returns, are they going to continue to follow? And are they really trailing the public markets? And how low will they go before they kind of rebound?

And kind of how does that -- if you were to graph it out, how is that versus publics? But yes, certainly, I think the down rounds, and as I mentioned, a lot of the things that are happening in the markets have contributed to those consecutive negative quarters, but it will be interesting to see how that plays out for sure.

Chris Sparenberg

So Jad, picking up on that point that you're making around trends that you're seeing. I want to flip to how the Cambridge Associates benchmarks have evolved over time. Certainly, when things started, you had a limited number of strategies, but really were first to market with data.

But as we've seen the emergence of new funds, new strategies, new -- different types of investments, certainly, that's grown, and it's been reflected in the Cambridge benchmarks. Could you please kind of talk us through your experience with that?

Jad Stella

Yes, absolutely. Happy to do that. So I think I mentioned this earlier, Cambridge started collecting this data for our original investors. In fact, that it was really just VC and PE and actually, recently, found the first reports that we were producing in the industry. So it was the late '90s. I think the year was 1997 that we first put out a report to the industry. And it was simply on two benchmarks, it was U.S. private equity, U.S. venture capital, but that was kind of our first publication, if you will, of the benchmark data to the industry.

As we move forward in time, early 2000s, we started to sprinkle in some different kind of geographic cuts. So adding in a global ex-U.S. VC and PE, calling out specific data sets for developed Europe, emerging markets, et cetera. And then as that decade, kind of through the mid-20s, progressed, that's really when we started to say, okay, here's a benchmark for distressed securities funds.

Specifically, fund to funds, oil and gas, natural resources investments, real estate, et cetera. So that was kind of the beginning in the late '90s through the 2000s. And I think we kind of established ourselves as kind of one of the go-tos, if you will, for this type of information. And given our role in the investment industry as well as being the providers of this data set, we've really tried to stay on top of new asset classes as they emerge.

Some specific examples would be growth equity, which we launched in 2008, infrastructure. And our view at Cambridge is a little bit different maybe than some others where it's a real true essential goods and services type of viewpoint in infrastructure. That was in 2015. Private credit in 2017, not quite as related to fund-level benchmarks but of the more complicated investment level reports.

Loss and impairment ratios were kind of closer to 2018, that type of thing. But really trying to evolve with the industry as investors see different strategies, as we see different strategies, as the scrutiny continues to grow and diligence and there's more demand for different types of data and really understand the performance of these investments, we've tried to really stay on top of that, just kind of a higher level overview of how that data set, we've seen that evolve over the years.

Jocelyn Lewis

That's really a lot of evolution. And to think where you started and where you are today, it's quite remarkable. Is there a critical mass? Or how do you determine kind of when you have enough information to really create a benchmark? Like I was just thinking about, you said growth equity, for example, is one of the more recent benchmarks. Like at what point in time did you say, I think we have enough information now?

Jad Stella

Yes, that's a great question, Jocelyn. So when we're thinking about releasing a new benchmark, we will kind of perform an exercise to try and define what the universe is. And again, we look at the benchmark to institutional quality funds for LPs only, but there are many out there, and we don't track them all. I wish we did.

But to get to a point where we feel comfortable releasing a benchmark can be somewhat circumstantial depending on what you're trying to do. But generally speaking, we try to capture a representative sample of that universe. And so if any of you in the universe, say, 1,000 funds, we want to try to have at least half of the funds that are in that universe or more to say that this is representative of that market.

And generally, when that happens through the relationships that we have with GPs, the number of dollars in the benchmark, if a 1,000 funds have raised $1 billion using simple numbers, we would want to have close to 2/3 or greater of the dollars captured. So when you're looking at the various metrics that we put out with the benchmark, you did know that it's a representative sample of more than half the funds, 2/3 or greater capital.

And we'll also kind of do such check to make sure that we're including most of the -- all of the major players in terms of the fund managers that one might expect that would be in that sample. So it's not an exact science but it's certainly something where we do take measures to try to make sure there's a level of responsibility around, okay, Cambridge feels comfortable this is a good data set that investors can look to as a benchmark of their portfolios.

Jocelyn Lewis

Yes. And as you mentioned, you have some experience in the benchmarking space. So we feel, if anyone, Cambridge would have a good sense of when it's time to actually publish something new when there's sufficient data. Well, that is great, Jad. Thank you so much for joining us today. You certainly shed some more light on the topic of private market benchmark. So thank you so much.

And for those of you who are interested in learning more about the private market benchmarks, please head over to S&P Dow Jones Indices page at spglobal.com/spdji to access the private markets indices and the associated content.

Chris Sparenberg

Thank you again to our wonderful guest for a great chat today. We really appreciate everyone listening in. If you're looking for more private markets content, hit subscribe to catch future episodes and listen to our earlier episodes wherever you listen to podcasts. Cheers, everyone.

Jocelyn Lewis

Thank you so much. You can also subscribe to our monthly Private Markets 360 newsletter. The link is in each episode bio or connect with us on LinkedIn. Have a great day.