Executive Summary

Here’s why macro matters for private markets:

• Activity is cyclical – capital raising, deal flow, multiples, and returns all depend on growth, price, and financial conditions in the broader economy.
• Portfolio company performance varies widely depending on the macro situation – different industries have different outcomes in different scenarios.
• Macroeconomic conditions can be systematically monitored and planned for – with the right tools, private portfolios can be made more robust.

This White Paper establishes these conclusions by combining and analyzing scores of time series from private equity databases, hundreds of macroeconomic variables, and over a million data points from company financials.

Combining advanced econometric and data science tools with human experience and judgement, we’ve developed a system for tailoring macroeconomic insights to private markets that can help funds and allocators navigate macro uncertainty.

The system has three parts:

1. Macro: Tracking the economy and generating probability-weighted scenarios for its evolution.
2. Strategy: Teasing out detailed strategic and tactical implications for investing and fund management.
3. Asset performance: Identifying which industries and types of companies are best suited to the evolving landscape.

We are not challenging the core value proposition of the private markets industry; the best funds will always be those with the strongest ability to identify underperforming assets, improve them, and unlock value for investors. Illiquid funds are not good vehicles for making bets on macro risk.

Instead, we argue that, like it or not, any investment carries macro risk from inception. The ability to identify and monitor macro exposures can help clarify value-creation strategies and free managers and investors to do what they do best – find alpha.

What does it mean to tailor macroeconomics to private markets? How can private market funds better understand the macro landscape?

The first section of this White Paper focuses on the “macro.” We distill the information provided by 227 economic indicators into four monthly “factors” that track the real economy, prices, financial conditions, and sentiment, all in real time. Based on historical combinations of these factors, we define a set of seven distinct economic regimes that characterize the state of the economy and act as shorthand for the conditions investors should expect to be operating in.

Next, we introduce data on the various phases of the private equity fund lifecycle (fundraising, deal flow, valuations, and returns) and demonstrate how they co-move with the macro factors. We define the typical conditions that the privates industry faces during each macro regime and draw out the implications for investing strategy.

Then we zero in on the underlying assets, using quarterly data on revenue, profitability, and valuations from every company ever listed on U.S. exchanges. We estimate the distribution of the sensitivity of these financial indicators to our macro factors (calculating so-called “betas”) at the industry level. This tells us the degree to which the performance of top, median, and bottom-quartile companies is influenced by the state of the broader economy.

Finally, and most importantly, we tie it all together. We’re firm subscribers to the philosophy that well-constructed scenarios are far more helpful in business and investment planning than point forecasts.

We employ sophisticated statistical machinery to estimate the probability that the economy will transition into different macro regimes over the next 12-36 months and combine this with professional judgement to maintain a set of arcMacro scenarios for the evolution of the U.S. economy. These can be tailored to any use case.

In each scenario, we detail the strategic implications for private markets – for example, whether to exit an investment in a weak return environment or extend the hold period in the hope that things improve – and identify how companies in different industries are likely to be affected.

The tools we develop in this paper have widespread applications extending beyond the basic framework we’ve described. We conclude the paper by outlining three indicative use cases, all of which relate to how investors might respond to the rising risk of an inflation surge.

The value in our framework in practice is clear. Our approach provides clarity during the diligence process. Our tools can identify whether an entire portfolio is over-leveraged to a certain macro factor. We can help define the thematic orientation of a new investment fund (e.g., “we only pursue inflation-resilient businesses”) or shape its approach to fund strategy (e.g., “high intervention in portfolio companies in pursuit of operational excellence”). And, on the other end of the fund lifecycle, we can inform critical decisions on exit timing.

Whatever the use case, private markets no longer have an excuse to ignore the macro.

We have the tools and insights to help navigate the uncertainty.