Morningstar - Q1 2023 - 45

10
8.82
8.21
8
EXHIBIT 5
6
7.29
7.09
Private Markets Starting to Feel
the Pain The Morningstar PitchBook
Global Unicorn Index fell into negative
territory in 2022.
12/2021
12/2022
Morningstar Global Markets Index
Morningstar PitchBook Global Unicorn Index
$12K
10
9.49
8.21
8
6
12/2021
Source: Morningstar Direct. Data as of Dec. 31, 2022.
12/2022
of the Morningstar PitchBook Developed Markets
Listed Private Equity Index, which includes
the shares of public companies focused on private
assets (Blackstone BX, KKR KKR, and Partners
Group PGPHF are top constituents). The
index, which relies on data from PitchBook, a
Morningstar company specializing in private
markets, rose more than twice as high as its
public counterpart for the five years through 2021.
As in many of the stories discussed above,
2022 saw a reversal of fortunes. The index fell
twice as far as its parent. Even as private
equity and venture capital funds continue to report
strong performance, public markets sniff
trouble ahead.
business models had yet to emerge. Even great
companies like Amazon.com carried valuations
that implied unrealistic expectations. It took
years for Amazon to regain its 1999 valuation and
for companies like Google and Facebook to
come to market.
The struggles of many thematic indexes in
2022 did not invalidate their themes in the long
term or mean the wrong securities were
selected. The Morningstar thematic indexes cited
above use equity analyst insights to identify
themes and companies poised to benefit
from them. Similar to the discussion of sustainable
investments above, it points to the inevitability
of performance cyclicality for any deviation
from the market portfolio.
It also speaks to the importance of valuation. In
the case of the Morningstar Exponential
Technologies Index, a portfolio of overvalued
growth stocks harmed performance in 2022.
Lesson 5: Private Markets Don't Only Go Up
One way to measure the boom in private-market
investing in recent years is the performance
Measuring returns for private companies that
are not marked to market is difficult, though
the Morningstar PitchBook Global Unicorn Index
and its regional carve-outs attempt to do just
that. To value constituents such as ByteDance,
Stripe, and SpaceX, the indexes employ a
pricing model that considers not just a company's
valuation as of its last funding round, but
comparable data from both private- and publicmarket
peers. The cohort of private companies
with $1 billion-plus valuations lost steam
last year, with estimated valuations for the 1,215
companies in the global unicorn index
showing the group having lost more than 5%
of collective value in 2022 ( EXHIBIT 5).
Because pricing is estimated, magnitude is
less important than direction. In 2022, we saw
the high-profile crash of Klarna, whose
85% valuation haircut was reminiscent of the
WeWork WE debacle, and the well-publicized
blowup of cryptocurrency exchange FTX.
Propping up index returns were massive
fundraising rounds from companies like Shein,
a Chinese fast-fashion business, and SpaceX,
whose valuation climbed to $127 billion
in June. Whereas public markets can often be
leading indicators, it can take time for private
markets to reflect change.
Unicorn creation, a key metric, has slowed.
The number of index constituents grew from 986
at the start of 2021 to 1,215 at year-end.
In 2021, the global unicorn index saw its ranks
swell from 574 to 986 by year-end. PitchBook
observes that private-market deal flow has
also slowed.
Headwinds include rising interest rates, potential
recession, and public-market struggles.
Unicorns looking for an exit do not want to IPO
in a down market. Many have cash on hand
and are biding their time. But a reckoning
may be imminent. In 2023, " we'll see companies
that are forced to come back to market in an
unforgiving environment, " warns PitchBook senior
analyst Kyle Stanford.
But no matter the short-term outlook, structural
factors mean private markets are likely to
remain an important feature of the investment
landscape. Regulation has made staying private
more compelling. Many companies are keen
to avoid the cost, disclosure requirements, and
scrutiny of public markets. Raising funds in
private markets is easier than ever thanks to more
than $11 trillion in assets in private equity,
venture capital, and other private-market vehicles.
According to PitchBook data as of Sept. 30, 2022,
$3 trillion of that capital is considered " dry
powder, " meaning it has been allocated but yet
to be deployed. Asset owners like pension
funds and sovereign wealth funds commonly
allocate 20%-plus to private assets. Crossover
investors, including equity mutual funds,
commonly hold stakes in private companies, and
efforts are being made to broaden access to
small investors. (See " Tracking Unicorns in
Mutual Funds, " Page 34.) Even if we're in for a
downturn in private markets, it's likely that
an increasing number of future portfolios will
feature both public and private assets.
Accept Uncertainty
Ultimately, one year is a short time frame in
investing. For many, the best course of action
is to tune out and hang on. Investment
performance in 2022 may end up as a small blip on
a long upward-sloping chart. More important,
perhaps, are the lessons that have been learned-
about expecting the unexpected, preparing
for the worst, and accepting how little certainty
there is in investing. K
Dan Lefkovitz is a strategist at Morningstar Indexes.
morningstar.com/products/magazine
45
https://www.morningstar.com/stocks/pinx/pgphf/quote https://www.morningstar.com/stocks/xnys/bx/quote https://www.morningstar.com/stocks/xnys/kkr/quote https://www.morningstar.com/stocks/pinx/pgphf/quote http://www.Amazon.com https://www.morningstar.com/stocks/xnys/we/quote https://www.morningstar.com/authors/601/dan-lefkovitz http://www.morningstar.com/products/magazine
Morningstar - Q1 2023

Table of Contents for the Digital Edition of Morningstar - Q1 2023
