Where Have All the Cash Flows Gone?

 

Patrick Warren, Burgiss*
Luis O’Shea, Ph.D., Burgiss*

 

Key Takeaways

  • In the first half of 2022, Burgiss Manager Universe (BMU) Private Equity and Private Debt distributions declined more than contributions did; however, Real Assets offered a somewhat rosier picture.

  • Cash flows from the BMU provide a close look at distribution behavior, but we can reweight these cash flows to approximate a “mature” portfolio by asset class. This approach produces information that is far more relevant to Limited Partners (LPs) who manage self-funding portfolio strategies.

  • Our mature portfolios indicate a divergence in net distributions (distributions minus capital calls): some strength in Real Assets and real weakness in Private Debt. Private Equity falls somewhere in between, with net distributions positive, but only just.

LPs often depend on private capital distributions to fund outstanding commitments, which can include other private capital funds, benefits to plan participants, and operations-related costs. In the first half of 2022, public market volatility coincided with a notable drop in distributions across many BMU asset classes, especially Private Equity and Debt. While capital calls also fell to more normal levels after a busy end of 2021, it is not clear whether these asset classes are making net distributions; this could potentially create a problem for LPs with self-funding portfolios. In this blog post, we look at recent private market cash flows and what they could mean for LPs going forward.

Raw BMU data provides a simple approach to looking at cash flows—we can take the funds in an asset class and just add the distributions and contributions, as illustrated in figure 1. Net distributions to LPs, which are critical for LPs who manage cash flows, are displayed with a black line. We tend to see signs of seasonality in this chart, with less cash flow activity in the first quarter (lighter bars) than the rest of the year—this is most obvious when looking at Buyout. It was challenging to evaluate the drop in cash flows in the first quarter of 2022 because it was unclear how much of the fall was due to seasonal effects. Yet with the newly released second quarter data, we see cause for concern in some asset classes. In particular, Venture Capital’s net distributions are now at a multi-decade low, and Senior and Distressed Debt are also calling capital on net. However, this approach of simply adding up BMU cash flows is probably not the best one that an LP can take.

The BMU uses market weights, meaning that each fund is weighted according to its fund size. Private market vintage capitalization tends to grow over time due to an increase in both the number of funds and the fund size; this creates a life cycle problem whereby the market gets younger over time. Younger portfolios will generally produce more capital calls relative to distributions because more funds will be early in the J-curve. While this is the appropriate way to view the market, our goal in the remainder of this blog post is to disentangle changes in fund behavior—cash flows—from this demographic effect within a more realistic portfolio.

 

Fig. 1: Quarterly cash flows from BMU funds through Q2 2022. Distributions are in green; contributions are in blue. The first quarter of every year appears as a lighter shade. The black line indicates net distributions (distributions minus contributions).

 

LPs generally have target allocations that are different from the market, even within an asset class. Portfolios often ramp up to a given size, with regular annual allocations leading to a steady state as a “mature” portfolio. In figure 2, we reweight the BMU to create such a portfolio—one that emulates an LP allocating $100 to each vintage of an asset class.[1] The chart plots the cash flows from these steady-state asset class portfolios. Visually, the differences between the gross cash flows in figure 1 and figure 2 are subtle, but the net distribution lines differ dramatically for all asset classes, except Real Estate. Correcting for the greening of the BMU, in which new vintages with young funds grow relative to previous vintages, a somewhat more reassuring picture for self-funding LPs appears.

 

Fig. 2: Quarterly cash flows from BMU funds through 2022Q2. Distributions are in green; contributions are in blue. Funds are reweighted such that each vintage within an asset class receives a $100 commitment, emulating a steady-state portfolio. The first quarter of every year appears as a lighter shade. The black line indicates net distributions (distributions minus contributions).

 

While the net distributions in the steady-state portfolios are less dire than those in figure 1, we still see challenges that lie ahead for allocators. Private Equity asset classes generated growing net cash flows for LPs in recent years, but this came to an abrupt stop in the first half of 2022; net distributions are now only slightly positive. While Private Debt net distributions were more mixed over this period, these asset classes are now net capital callers. The results are less dramatic in steady state, but can still cause strains for self-funding LPs. In contrast, Real Assets appear to be a relatively bright spot—while net cash flows in Real Asset subcategories are noisy, they are performing reasonably well now compared to in recent history.

 

Conclusion

BMU cash flows present an interesting view of private markets, but for an LP who is concerned about funding commitments out of distributions, it is important to know that using market weights hides some crucial details. By reweighting the BMU, we provide a more useful look at the cash flows of mature asset class portfolios. These cash flows show signs of trouble for Debt portfolios, which are net capital callers so far in 2022. In contrast, Real Assets have maintained relatively strong net distributions. Finally, Private Equity falls somewhere in between—net distributions are down dramatically after a spectacular 2021, but still slightly positive. With the private capital cash flows giving LPs mixed signals, it is more important than ever to maintain a diversified portfolio. Stay tuned to see how a diversified private asset portfolio would have fared in comparison.

 

* We thank Greg Kohles (Burgiss) for his insightful discussion on the subject.

[1] Within an asset class and vintage, we use market weights based on fund size.

 
Ruby Atwal