Diversification is often cited as one of the most effective forms of risk management. The current market environment has impacted investments across asset classes and industries in a wide variety of ways. Many companies have seen significant demand shocks, both positive and negative. Diversified investors have derived value from their positioning by gaining exposure to companies that have, at least until now, proven resilient in the current environment, offering some relief from more directly impacted companies. In the private markets, we have witnessed surging demand in companies that focus on remote work applications (see 5/14 COTW), data centers, esports, biotechnology and consumer packaged goods, helping to offset significant weakness in multisite businesses (doctors’ offices, gyms and restaurants), hospitality, airlines and energy. Also, strategies focused on the top of a business’s capital structure (senior loan strategies) are proving more resilient than those focused on more junior parts of balance sheets (mezzanine and preferred equity). Those that employ leverage (levered direct lending) have been more impacted than those that haven’t.
One form of diversification that is often underappreciated is the practice of investing patiently and prudently over time. In the context of private markets, diversification is referred to as vintage year diversification. This week’s chart shows median global private equity returns by vintage year, revealing that the best vintages appear correlated with weaker economic conditions. Generally, during times of weaker economic growth, capital is scarce, pricing becomes more attractive and the opportunity set expands. It is difficult to time the market, so maintaining a patient, consistent investment pace is generally the best approach to time diversification.
Today, it is difficult to know if we’ve seen the bottom in markets or if there is further downside yet to come. However, history shows that patient and consistent investors are more likely to capture the most attractive entry points. The statistics are pretty clear. Across private asset classes, many of the best returns were born out of prior financial crises. Anecdotally, looking at venture capital, WhatsApp, Venmo, Uber, Slack, Instagram and Square were all founded in the wake of the global financial crisis (GFC). Going further back in history, General Electric was launched in 1892 just prior to the Panic of 1893, Disney was launched in 1929 at the beginning of the Great Depression and Microsoft launched in 1975 at the tail end of the 1973 oil crisis and stock market crash. About 10 years later, in 1986, the Microsoft IPO led to the generation of significant wealth for its founders and thousands of shareholders. None of the entrepreneurs knew what the future would hold when they launched their ventures and neither did their capital partners. There are many other asset classes and strategies that provide their own examples of opportunities coming out of extremely challenging times.
Diversification can help reduce portfolio volatility. It is important to think about diversification in terms of asset class, industry and strategy, as well as vintage. Those investors who are able to put capital to work consistently across cycles will likely yield the best results.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
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