ALTERNATIVE MARKETS UPDATE - H1 2022 SUMMARY

 Alternative Markets Summary H1 2022
Ever since Covid-19 has subsided from the daily news, inflation has taken over. Inflation is still a major concern in the current economy. This is further exacerbated by central bank interventions that have not been fruitful yet. An additional major contributor is the ongoing war between Russia and Ukraine. As of June 2022, inflation in the US is at 9.1%, the highest it has been in the past 40 years. In the Eurozone, inflation is slightly lower at 8.6%. The UK’s inflation is even higher at 9.4%. Asian countries, such as Japan and China, managed to keep their inflation relatively low at 2.4% and 2.5%. The development of inflation over the past year is summarized in Figure 1. For Western countries, inflation has more or less continuously risen. The US started the year with inflation close to over 5%, while European countries were close to 2%. Nonetheless, Europe has caught up to the US since April, when the UK’s inflation even got higher than the US’s. A potential reason for the higher inflation in the US at the beginning of the year and back until the latter half of 2021 is the rapid and steep unconventional measures taken by the Fed. This faster intervention led to more money being in the economy earlier, which theoretically should lead to higher inflation earlier. Figure 2 shows the growth in the balance sheet indexed to January 2019. Once Covid-19 hit the economy, the US reacted a lot faster and in higher magnitudes than Europe did. Within the first months, the Fed’s balance sheet grew by almost 70%, while the ECB’s only grew by 25% in the same time frame. Since then, the two central banks acted equivalently in terms of balance sheet growth. Very recently, the central banks started to shrink their balance sheets. These measures were announced during Q2 2022 and are slowly implemented. Going forward, this balance sheet shrinking will be strengthened, which is confirmed by an announcement from the ECB recently. Nonetheless, as the graph shows, these measures barely affect the original measures taken to combat the economic consequences of Covid-19. The low inflation in China largely stems from the consequences of their zero-Covid policy. In recent months, many places have been shut down to control the spread of Covid. This led to low production levels and low demand which is reflected in the low inflation levels of the country. In the case of Japan, inflation of above 2% is significant, as the average inflation during the past three decades was only 0.3%. Its inflation largely stems from the consequences of the war and the impact it has on food and energy.

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RESEARCH PERSPECTIVE VOL. 184 July 2022 Alternative Markets Summary H1 2022 Ever since Covid-19 has subsided from the daily news, inflation has taken over. Inflation is still a major concern in the current economy. This is further exacerbated by central bank interventions that have not been fruitful yet. An additional major contributor is the ongoing war between Russia and Ukraine. As of June 2022, inflation in the US is at 9.1%, the highest it has been in the past 40 years. In the Eurozone, inflation is slightly lower at 8.6%. The UK’s inflation is even higher at 9.4%. Asian countries, such as Japan and China, managed to keep their inflation relatively low at 2.4% and 2.5%. The development of inflation over the past year is summarized in Figure 1. For Western countries, inflation has more or less continuously risen. The US started the year with inflation close to over 5%, while European countries were close to 2%. Nonetheless, Europe has caught up to the US since April, when the UK’s inflation even got higher than the US’s. A potential reason for the higher inflation in the US at the beginning of the year and back until the latter half of 2021 is the rapid and steep unconventional measures taken by the Fed. This faster intervention led to more money being in the economy earlier, which theoretically should lead to higher inflation earlier. Figure 2 shows the growth in the balance sheet indexed to January 2019. Once Covid-19 hit the economy, the US reacted a lot faster and in higher magnitudes than Europe did. Within the first months, the Fed’s balance sheet grew by almost 70%, while the ECB’s only grew by 25% in the same time frame. Since then, the two central banks acted equivalently in terms of balance sheet growth. Very recently, the central banks started to shrink their balance sheets. These measures were announced during Q2 2022 and are slowly implemented. Going forward, this balance sheet shrinking will be strengthened, which is confirmed by an announcement from the ECB recently. Nonetheless, as the graph shows, these measures barely affect the original measures taken to combat the economic consequences of Covid-19. The low inflation in China largely stems from the consequences of their zero-Covid policy. In recent months, many places have been shut down to control the spread of Covid. This led to low production levels and low demand which is reflected in the low inflation levels of the country. In the case of Japan, inflation of above 2% is significant, as the average inflation during the past three decades was only 0.3%. Its inflation largely stems from the consequences of the war and the impact it has on food and energy. Figure 1: Inflation Across the World from July 2021 to June 2022, Source: Trading Economics, US Bureau of Labor Statistics, EUROStat, Office for National Statistics, Ministry of Internal Affairs & Communications, National Bureau of Statistics of China, July 2022 Figure 2: Balance Sheet Growth of the Fed and the ECB Indexed to January 2019, Source: Federal Reserve of St. Louis, European Central Bank, Board of Governors of the Federal Reserve System, July 2022 Although inflation would have been a problem regardless of the war, it further exacerbated the issue. The implications of the war are the key reasons for the strongly surging inflation across the world. Essentially, it comes down to two factors, food, and energy. Both Russia and Ukraine are key suppliers of food, in particular wheat. Russia additionally is one of the largest exporters of oil. The sanctions imposed on Russia by the West have led to substantial cuts in oil and gas exports to Europe. Currently, Europe is threatened to lack the necessary amount of energy to heat in the winter and it is expected that current reserves will only last until February. In terms of wheat supplies, one can be cautiously optimistic. It looked very grim a couple of weeks back, as Russia started burning down fields of grain. However, recently Russia and Ukraine came to an agreement to resume Ukraine grain exports from the Black Sea ports which may ease the global food crisis. It remains questionable whether this agreement will hold even in the short term. Although these factors affect Europe directly, they significantly impacted the world due to the rise in costs following supply issues. Figure 3 summarizes the impact of the prices of these goods in the US and Europe. Food inflation was continuously increasing since 2021, which may have happened naturally through an increased money supply. However, since the tensions between Ukraine and Russia increased, food inflation substantially increased especially in Europe. The differences between the US and Europe in energy inflation substantially differ. Europe’s energy prices were deflationary in mid-2021 and surged to almost 30% in June 2022 amid the energy crisis the continent is facing. In the US, energy inflation was already 25% in mid-2021 and was calming down ahead of the official start of the war. This was not concerning, even though the numbers were high, as in mid-2020 oil prices were extremely low. However, since the war started, energy inflation is surging again, and it surpassed the 40% mark in June 2022. In the US, the impact of these two goods on inflation is substantial, as the core CPI is below 6% in June 2022. While food and energy are responsible for more than 3% of inflation now, it was less than 1% one year ago. As implied by the high energy inflation, prices of energy sources have substantially increased. Figure 4 shows the cumulative growth rates of WTI crude oil and US natural gas. Oil has been steadily rising ever since its slump in early 2020, which is captured in the graph before the war started. Prior to the war, WTI was oscillating between the $70 and $80 per barrel mark with the expectation of slightly higher prices. Once the war started, oil immediately surged and reached levels of almost $130 per barrel. Since then, WTI largely remained close to the $100 mark. In early 2021, natural gas experienced a stronger growth than oil which was largely because of the deviation in growth beforehand. When the war started, it was not immediately evident that gas will become the crucial lacking good. Once Russia was sanctioned more and more, it retaliated by imposing restrictions on gas exports, either by paying in Russian Rubles or cutting their exports. This triggered a strong bull run in the natural gas market, as it became clear that there will be supply problems ahead. Although it cooled in June 2022, this price relief was short-lived. This was the case, as Russia further cut supplies by virtue of the supposed maintenance of the Nordstream pipeline. Additionally, Europe realized that there may not be enough gas around to supply heating during the upcoming winter. Figure 3: Food Inflation (left) and Energy Inflation (right) in the US and Europe from July 2021 to June 2022, Source: Trading Economics, US Bureau of Labor Statistics, EUROStat, July 2022 Figure 4: Comparison of Cumulative Growth Rates of Natural Gas and WTI Crude Oil from July 2021 to July 2022, Source: Nasdaq, Federal Reserve of St. Louis, US Energy Information Administration, July 2022 The rampant inflation also forced central banks to bring it down to reasonable levels or at least stop the ever-increasing inflation growth at the moment. The Fed started its interest rate hikes in March and continuously increased the steps it took, as the measures did not help bring down inflation. Inflation reports over the current months mostly underestimated the actual values, and instead of bringing inflation down, it increased even further. The Fed reacted relatively slowly, as the first hike came just as inflation reached 8%, even though it has been rising for the past year and topped the 5% mark already in January 2022. Figure 5 shows that interest rate hikes were anticipated way earlier as short-term interest rates were rising significantly since November 2021. The graph shows a comparison of the federal fund rate, and the yields of 1- and 10-year Treasury notes and bonds. The federal fund rate is currently between 2.25% and 2.5% after the highest inflation yet has been released for June 2022. It remains to be seen whether those recent 75bps hikes can slow down inflation or even bring it down to some degree. In contrast to the US, Europe reacted a lot slower, as the ECB announced its first interest hike in July 2022, the first hike in 11 years. The ECB raised rates by 50bps, which exceeded the expectations of market participants. It is unlikely that the ECB can increase interest rates similar to the Fed. The ECB has to consider all the countries in the European Union. This is relevant as some countries are on the brink of defaulting if interest rates rise. Italy is the most prominent example. Its CDS premium is up more than 100% in less than a year, which is commonly used as a proxy for the default risk. These developments also cause a decline in expected GDP growth in 2022 and the coming years. GDP growth forecasts are getting lower and lower by the quarter. The IMF expects a real GDP growth of 3.2%, down from 3.6% in April. These adjustments largely stem from the downturns in Q2 in China and Russia. Similarly, the Fed corrected its 2023 numbers to 2.9%, which is substantially lower than its 3.6% expectations from April. The ECB follows with downward adjustments. It expects a GDP growth of 2.8% in 2022 and 2.1% in 2023 and 2024. This is 0.9% and 0.7% lower than their forecast from March. In terms of the recession risk, it seems more and more likely that most Western countries will enter a recession going forward given the high inflation and probably soon high interest rates that further hurt businesses. While there have been many instances of interest rate inversions over the past two years, the current ecosystem points stronger towards a recession than before. Previously, inversions only occurred in the comparison of a few different maturities. Currently, inversions seem to be more unified across different maturities. Additionally, the inversions are rather persistent. The red area in Figure 5 highlights the inversion between the 1- and 10-year Treasury yield that has almost held for a month now and its gap is quite significant. Figure 5: Comparison of Federal Fund Rate, 1-Year Treasury, and 10-Year Treasury Rate from July 2021 to July 2022, Source: Federal Reserve of St. Louis, Board of Governors of the Federal Reserve System, July 2022 For equity markets, the current year almost feels like the recession is already raging, in particular for riskier strategies, such as the technology sectors. However, considering the strong 2020 and 2021 of equity markets that were largely asynchronous to the actual economy. The strong bull run of equity markets can be largely attributed to the fiscal and monetary measures taken by central banks. It is also notable that the stock market continued its bull run throughout the existing volatility in the market at the time. Figure 6 shows the development of the S&P 500 and the VIX index since 2020. Although the stock market lost substantially in value in H1 2022 with the S&P500 being down 15% YTD, it cannot be considered a recession, as this is merely a correction. As the figure shows, the level of the S&P500 is still way above its previous highs before Covid-19. This even holds for technology stocks, of which some have lost more than 90% this year. Historically, technology stocks with their current correction are at their average valuation. In terms of volatility, it cooled off during 2021 and started to rise towards the end, when it was evident that inflation will be a major problem. It further spiked after the war started in Ukraine, and volatility is staying high with the struggle to deal with the additional inflation induced by the war. Over the past months, there was also rotation in the equity markets. People now favor value stocks more than growth for obvious reasons. While growth stocks handily outperformed value stocks over the past two years, this changed as the uncertainty in the market is spiking and governmental support is largely discontinued. Figure 7 shows the cumulative performance of the value vs. growth stocks in the S&P 500 index over the past year. It clearly shows the superiority of growth stocks before inflation became concerning. However, with a substantial likelihood of a recession as well as the unfavorable market ecosystem, value stocks managed to mitigate the equity drawdown significantly. Figure 6: Comparison of the S&P 500 Index and the VIX Index from January 2020 to July 2022, Source: CBOE, The Wall Street Journal, July 2022 Figure 7: Comparison of the S&P 500 Value and S&P 500 Growth Index over the Past Year, Source: S&P Global, July 2022 Hedge Funds The hedge fund industry faced a tough 2022 so far, as most strategies’ underlyings declined. Notably, this includes both equity and fixed income. The year started decently, as the industry closed the first quarter approximately flat. While most strategies declined slightly (up to 5% depending on the strategy and the source), this was offset by sometimes huge gains in global macro and managed future strategies. In Q2 2022, the performance of the industry worsened. Preqin estimates the hedge fund industry is down -9.8% as of the end of June 2022. Figure 8 summarizes Preqin estimates across different strategies. Both Q1 and Q2 2022 have been the worst quarters since the global financial crisis in 2008 and after Q2 2020 when the Covid-19 crisis emerged. As shown in the figure, only macro strategies are positive in 2022, while equity and activist strategies disappoint with losses higher than 10%. At least, the strategies still outperform public markets. For these strategies, the deviation from the S&P 500 is rather small and such low downside mitigation is certainly not the goal of a hedge fund. Geographically, the return attribution has been interesting. In Q1 2022, North American hedge funds lost the least compared to European and Asian funds. However, in Q2 2022, this strongly inversed, and North American funds lost substantially more than their geographical counterparts. Figures 9-13 summarize the performance of the SMC strategy indexes and suitable benchmarks. The SMC Equity Strategy Index performed poorly compared to other equity hedge fund benchmarks, which is largely due to the nature of being a composite of risky equity strategies within the space. The SMC Credit Strategy Index managed to handily outperform all but one benchmark. The most noteworthy is the Trade Finance Crypto strategy that achieved a YTD of 5.53%. The highlight in the current market ecosystem is the SMC Global Macro Strategy Index which returned almost 70% in 2022 so far, which is more than 50% more than any other benchmark. This is largely due to the highly successful Discretionary Global Macro strategy that returned 170% as of the end of June. Figure 8: Performance of Hedge Funds in Q2 2022 and Over the Past Three Years, Source: Preqin Pro, July 2022 Figure 9: Performance of the SMC Equity Strategy Index Compared to Benchmarks in H1 2022, Source: Stone Mountain Capital Research, July 2022 Figure 10: Performance of the SMC Credit Strategy Index Compared to Benchmarks in H1 2022, Source: Stone Mountain Capital Research, July 2022 Figure 11: Performance of the SMC Global Macro Strategy Index Compared to Benchmarks in H1 2022, Source: Stone Mountain Capital Research, July 2022 Figure 12: Performance of the SMC Cryptocurrency Strategy Index Compared to Benchmarks in H1 2022, Source: Stone Mountain Capital Research, July 2022 Figure 13: Performance of the SMC Fund of Hedge Funds Strategy Index Compared to Benchmarks in H1 2022, Source: Stone Mountain Capital Research, July 2022 Despite the generally unimpressive return of the hedge fund industry, the AuM grew in Q1 2022. According to BarclayHedge, the industry’s AuM is currently at $5.1tn. However, it is important to notice that BarclayHedge tends to be on the higher end of estimations, as it is typically $300-$400bn higher than estimates of other sources, such as Preqin and HFR. The dispersion in AuM in the industry is significant, as eVestment estimated an AuM of only $3.6tn as of Q1 2022 as an example. Figure 14 shows the strong growth of the industry over the past three years. While the growth of the industry’s AuM seems very strong and consistent since Covid-19 started, it needs to be viewed cautiously, as the growth comes from various sources. The immediate increase in AuM following Covid-19 largely stems from the performance of the industry that persisted throughout 2021 but has significantly slowed down and became negative in 2022. Towards the end of 2020 and throughout most of 2021, the inflow in the industry has been strong which further pushed the AuM. This was a very notable development, as the industry mostly saw net outflows before. This occurred because market participants mostly perceived hedge funds as strong during the Covid-19 crisis and their ability to mitigate downturns and the subsequent strong growth alongside equity and commodity markets. This favorable perception is likely to change in 2022, as the drawdown of the industry is significant in 2022. In Q4 2021, the industry had net outflows for the first time since Covid-19. The surprisingly good result in Q1 2021 largely stems from the bounce back of redemptions in Q4 2021. In Q2 2022 and in the quarters ahead, it is very likely that the industry will face net outflows again. This combined with the negative performance will result in a possibly substantial decline in AuM. Figure 14: Historical AuM of the Hedge Fund Industry from Q1 2019 to Q1 2022, Source: BarclayHedge, July 2022 There has been a substantial shift in the launch of hedge funds, in particular the strategies the funds pursue. Compared to Q3 2021, there is a notable increase in equity and credit strategies in Q2 2022, which is surprising given that the state of the two asset classes is not great. However, in such volatile markets, there are a large number of opportunities and with it potential to distinguish themselves from other funds within the same strategy style. These increases in fund launches are largely due to the strong decline in niche strategies. It is possible that this steep decline stems from cryptocurrency strategies, as it is unlikely that many such funds were launched in 2022 given its large drawdown and the large number of launches last year. Figure 15 shows a summary of the strategies pursued by launched funds in the past year. The industry is doing well in terms of new fund launches in 2022. HFR reports that 185 new funds were launched in Q1 2022, which is the second highest number since 2017. It is substantially higher than the 113 funds launched in Q4 2021. Most fund launches were equity and global macro strategies. Equity-based hedge funds are almost always the most launched strategies, just by the percentage number that they make up in the hedge fund industry. The rise in global macro strategies is also straightforward, as these strategies are more or less the only strategies that did well in 2022 so far. Figure 15: Hedge Fund Launches in Percentages of Strategies from Q3 to Q2 2022, Source: Preqin Pro, July 2022 Cryptocurrencies / Blockchain Cryptocurrencies struggled in 2022 so far. They had phenomenal years in 2020 and 2021. As risky investments with extremely high liquidity, they paid the price in the current downturn. Initial claims heralded Bitcoin (BTC) as digital gold, which was a reasonable claim at the beginning of the Covid-19 crisis. Many investors, including institutional investors, start their investments in BTC and after some experience switch to other coins. However, as all cryptocurrencies, with the exception of stablecoins, are very risky assets, they were liquidated as the market started to drop substantially. Since the crypto market is still retail-dominated, this usually results in very steep declines in short time periods. Figure 16 shows the value of selected cryptocurrencies in 2022 relative to their value at the beginning of the year. BTC as the most stable cryptocurrency bottomed at 40% of the value it had at the beginning of the year. It is also notable that at that time, BTC was trading at $47k, already substantially down from its previous record of $69k. Ethereum (ETH) dropped to slightly less than 30% of its initial value this year, while other less established coins, such as Solana (SOL) were temporarily trading below 20%. Over the past few weeks, the industry managed to reclaim some of its value, which was further elevated by the Fed’s decision at the end of July. Currently, BTC is trading between $24k and $25k. ETH also managed to increase notably from its low of less than $1k to over $1.7k at the moment. SOL’s recovery was less impressive, as it still trading just above the 20% mark compared to the beginning of the year. Despite this sharp decline, it should not be overvalued, as the crypto industry has a history of sharp declines. Even the crash in 2017/18 was not among its worst. Over time, its crashes have become less and less steep, which is likely due to more investors being committed to the space, as well as investors being in the space for the long term. Historically, Bitcoin dominance has been a relatively good indicator of crises in the crypto market. Bitcoin dominance is measured by the market capitalization of Bitcoin relative to the entire cryptocurrency universe. In recent times, a value of 40% has been a solid benchmark as a crisis indicator, especially if there are steep declines ahead. Figure 17 shows the market cap of BTC and ETH since the 2017/18 crisis. Figure 16: Current Value of Bitcoin, Ethereum, and Solana Compared to the Beginning of the Year, Source: CoinMarketCap, July 2022 Figure 17: Bitcoin’s (Orange) and Ethereum’s (Blue) Share of the Total Market Capitalization Since Mid-2017 to July 2022, Source: CoinMarketCap, July 2022 The recent drawdown in crypto markets also significantly affects market capitalization. In June 2022, the industry’s market cap even fell below the $1tn mark after being more than $2.5tn in 2021. Thanks to its recent bounce back, the market cap could slightly recover to $1.1tn. Figure 18 shows the dramatic growth and decline of the industry’s market cap over the past year. The reasons for the recent drawdowns are diverse. Firstly, as the highest risk asset, it is natural that the asset allocation is reduced in times of high volatility and a crisis situation. Secondly, the asset class had a relatively consistent and high correlation to equity markets which further exacerbated the issue. Thirdly, 2022 was a tumultuous year for the crypto space itself. Ongoing legal issues and discussions about how these assets should be treated from a regulatory perspective induced further volatility. The collapse of significant coins did not help matters either. The most notable crash is the eradication of TerraUSD (LUNA), during which $60bn was wiped out over hours. Figure 18: Total Market Capitalization of the Cryptocurrency Market Over the Past Year, Source: CoinMarketCap, July 2022 In terms of specific areas within the crypto space, developments were highly distinct. Established applications of the blockchain space, such as decentralized finance (DeFi) and non-fungible tokens (NFTs) have declined substantially. Newer applications, such as metaverse and blockchain-based gaming have attracted substantial interest from the community. While DeFi was of high interest during 2021, it has shifted more to the background. However, in the dedicated community that focuses more in-depth, it remains highly important. It has the potential to disrupt many of the existing inefficiencies in the current financial system. This includes cross-border transactions that take days and can be very expensive, and substantial transaction costs to name a few. Despite these huge potential advantages, the market value of these disruptions is relatively low in the crypto space, as shown in Figure 19. It shows the market capitalization of DeFi applications since the beginning of 2021. This can be explained relatively easily, as the market capitalization is measured by the cryptocurrencies that are used to back these applications. As cryptocurrencies have suffered substantial drawdowns, DeFi applications were hurt as well. This is in particular the case, as very few use BTC and instead use much more volatile underlyings. However, this measure does not fully reflect the investments made in these technologies, as many established players in the field also have to adapt to these changes. These, sometimes major investments, are not reflected in this measure and are likely to be substantially larger than implied by the cryptocurrency market capitalization of DeFi. NFTs also shifted more to the background than in 2021, when they were the new invention in the space and were covered widely in news and by crypto enthusiasts. However, in comparison to DeFi, the industry suffered a lot less in terms of market capitalization. This is largely due to the emerging importance of the metaverse and blockchain-based gaming which largely rely on NFTs. In addition, the continuous releases of new NFTs also add additional capital to the space. Figure 20 shows the rise and fall of the market capitalization of NFTs over the past year. It peaked in February 2022 at almost $40bn and dropped to $25bn at the moment. While it is still relatively small, it is likely to grow with further usage in metaverse and gaming applications, in which it is a key tool for the economy of these applications. Figure 19: DeFi Market Capitalization from January 2021 to July 2022, Source: CoinGecko, July 2022 Figure 20: Market Capitalization and Volume of the NFT Market Over the Past Year, Source: NFTGo, July 2022 Private Equity The mainstream adoption of private equity is relatively new compared to other financial instruments. Thus, the industry has never experienced such high inflation and it remains to be seen how it will perform. As such events tend to be rather short-lived, at least for the usual time horizon of private equity funds, it is unlikely that it will affect the expected long-term performance much. LPs are likely to hold onto their PE allocations if not increasing them, as the industry tends to perform better than other asset classes, albeit at the cost of more risk. This is rather atypical in such an environment, but historically the industry has done well in crises, at least relatively speaking. In the US, the average private equity fund achieved a performance of 27% in 2021. In Q1 2022, this substantially declined to -0.35%. As private markets usually exhibit a time lag to public markets, it is highly likely that Q2 2022 will be worse. Depending on how long this situation will persist, this effect will be small over the usual 10-year horizon, especially considering the strong 2021. While the performance of the industry took quite a hit, fundraising, the number of deals, as well as exits, did not escape this development either. In the short term, the industry will face pressure. The strong year of 2021 and the deals done then are likely to limit the number of attractive deals currently available. Especially, technology investments that thrived in the past two years will be scarce and very risky given the drawdown of technology investments in public markets. A second important point is the rising interest rates and the loan issuance of banks. Banks will be more hesitant to lend money and will require more robust management of inflation and further rising interest rates. Valuations pose another issue, as they are delayed compared to public markets. This further induces uncertainty in the environment of the private equity industry. This uncertainty is also likely to slow down deals, as finding appropriate prices will be more difficult for buyers and sellers. Fundraising in the industry showed a relatively strong decline compared to previous periods. According to Preqin, Q1 and Q2 were the worst two quarters in fundraising in the past six years. The industry managed to raise funds around $250bn, which is substantially lower than in 2021. In either Q1 or Q2 2021, more money was raised than in the entire H1 2022. These findings are summarized in Figure 21. The number of funds raising capital stayed at similar levels since Q3 2021 at around 150 per quarter. In terms of strategies, buyout funds saw the largest declines by far, while venture capital declined the least. Nonetheless, even its decline was substantial. This decline was to be expected, especially considering the hugely successful 2021. Investors are rather hesitant, as the number of exits is greatly reduced this year which leads to a lower amount of cash flowing back to investors. Additionally, in the short term, investors are cautious, as the prospect is not great. Moreover, private markets lack behind the public market. Thus, many investors want to wait until the worst is over and commit capital afterward. This time lag to public markets also makes the total asset allocation to private equity larger, which discourages further investments. Essentially, it will come down to a trade-off between holding money or investing it into rather safe assets, and hoping inflation does not consume a significant portion of it or investing it into risky assets that have historically done very well after the crisis, as is the case for private equity. Figure 21: Global Quarterly Private Equity Fundraising from Q1 2017 to Q2 2022, Source: Preqin Pro, July 2022 Over the past years, the industry managed to continue to attract more capital than the industry could spend, which increased the available dry powder. The current drop in fundraising as well as the amount of capital deployed in 2021, has led to the first decline in dry powder since 2012. Despite this negative development, the dry powder is still the second highest it has ever been at more than $1tn. Figure 22 shows the value of the industry divided between dry powder and unrealized value. The industry managed to grow significantly thanks to its success in 2021. The industry now manages assets of more than 4.5tn. With such a dry powder in the industry, it has the luxury to sit out the crisis and act opportunely when attractive deals are found. Although investors do not favor capital lying around for a longer time, due to the management fees, it may be a feasible way to weather the storm in the current ecosystem, especially when considering the larger gains following a crisis in recent history. There also seems to be a shift in preferred strategies from investors, as shown in Figure 23. The available dry powder for buyout funds remains similar to 2021, which is large because of the lack of opportunities and the downward trajectory in the current ecosystem. Venture capital rose in dry powder which stems from the large inflows in 2021 after they posted a stellar return of more than 50% in the US. Maintaining the current AuM will be difficult for the industry as valuations are dropping and fundraising is scarce. Aside from these developments, the decline in the number of exits will not help matters either. Unsurprisingly, exits have become much rarer than in 2021 which has been the strongest year in terms of IPOs by a large margin. With crashing equity markets and a substantial chance of a recession ahead, the prospect of an IPO is much less appealing. Compared to H1 2021, IPO values have dropped by almost 75%, of which most were in Asia-Pacific and barely any in Europe or North America. Figure 22: AuM and Dry Powder of the Private Equity Industry from 2012 to 2021, Source: Preqin Pro, July 2022 Figure 23: Global Dry Powder in the Private Equity Industry by Fund Type Since 2003, Source: Preqin & Bain & Company, July 2022 Venture Capital Venture capital has shown to be resistant to the current market ecosystem in 2022 so far. In most instances, the industry could not connect to its record highs across the board from 2021 but is mostly on track to be the second most successful year in its history. It is widely expected that the industry will see a mild but sustained decline during the current crisis. How severe it will depend largely on how long the crisis will persist. Especially fundraising is performing very well, which is largely due to the time lag involved in these processes. One indicator of the struggles ahead stems from mega-deals which are much less frequent than they were in 2021. 2021 attracted a lot of capital as US VC funds achieved a return in excess of 50%. In Q1 2022, they underperformed the private equity industry by around 3%. Following the strong growth in 2021, the global VC industry reached an AuM of more than $2tn as of September 2021. As mentioned previously, fundraising is doing very well. In both Q1 and Q2 2022, $50bn - $60bn were raised which is on par with the most successful quarters over the past five years. In terms of funds raising capital, the numbers are very low compared to other quarters, which implies a trend toward larger funds. Figure 24 summarizes these findings. Going forward, it is likely that fundraising will decline by a considerable margin. In Europe, fundraising follows the trajectory of the global VC development. Despite the unfavorable short-term outlook, it is expected that fundraising in 2022 will be the second best year in the industry’s history. Figure 24: Global Venture Capital Fundraising from Q1 2017 to Q2 2022, Source: Preqin Pro, July 2022 The growth of the VC industry has been stellar over the past years. While the industry did not manage $1tn before 2018, it surged to $2.25tn as of the end of 2021. The growth of the industry largely stems from the increased valuations, which are likely to adjust downward due to the correction in public markets that will spill over to private markets. As discussed in the section about private equity, dry powder has increased substantially over the years, in particular for venture capital. Compared to other strategies in private equity, venture capital even managed to increase its dry powder. Figure 25 shows a summary of the global VC AuM and dry powder since 2009. Although the market seems a bit dry of many deals in 2021, the industry still finds a large number of deals. Most of these deals are in information technologies, of which fintech, infosec, and healthtech are especially sought after. In Europe, VC deal values are largely dominated by late-stage VC, which makes up more than 60% of the space. 2022 is the first year since 2018 when the share of late-stage VC declined albeit by a very low amount. Angel and seed investment continue to be less than 10% of the space. In line with the general development, the deal sizes are getting larger over time. While this was clear in 2021, it is surprising that the deal size of more than €25m grew substantially in 2022 compared to 2021. In the industry, it is widely expected that deals will decline but it is expected that will take place steadily rather than in a form of a crash. This, in turn, will present opportunities with lower valuations and high dry powder, which will stimulate deals again and help reclaim at least pre-Covid levels. European VC funds have conducted deals worth more than €100bn compared to less than €50bn in any other year before. 2022 shapes to be similar, as it already surpassed the €50bn mark by Q2 2022. Figure 26 shows the development in deal value and count since 2012, and highlights the steep growth of the industry in spite of difficult macroeconomic conditions. Globally, the industry made deals of around $140bn in each quarter in 2022. This is only below the quarters in 2021 and higher than any quarter in any year ahead of 2021. Figure 25: Global AuM of the Venture Capital Industry from 2009 to December 2021, Source: Preqin Pro, July 2022 Figure 26: European Venture Capital Deal Activity from 2012 to H1 2022, Source: Pitchbook, August 2022 Exits have been more troublesome for the industry. Historically, trade sales make up more than 50% of exits, with write-offs and IPOs being the second and third largest type of exit. Since Q3 2020, exits have become larger and IPOs are a key reason for it. Given the relatively high degree of tech-based companies in VC funds, the strong rise in exits, especially IPOs, is obvious given the soaring stock market. Since Q3 2021, exits have declined significantly, especially in Q2 2022 with only $60bn compared to Q2 2021 which almost hit $200bn. European VC funds saw even more extreme results. In 2021, exit activities amassed to €136bn compared to only €25bn as of H1 2022. Figure 27 summarizes the exit activity over the past ten years. In spite of this decline, 2022 shapes to be a very good year for the industry, as it is on track to be the second most successful year. This dramatic decline is also easy to identify. 2021 was a great year for public companies with soaring valuations from which many private companies want to profit. In that light, 2021 was a very unique year and it is more accurate to compare the current levels with other years. Of those €136bn, almost €100bn came from public listings, which in 2022 shrank to about €10bn. The path towards the end of the year is rather uncertain, as exit activity is likely to slow down in this currently highly volatile ecosystem. Figure 27: European Venture Capital Exit Activity from 2012 to H1 2022, Source: Pitchbook, August 2022 Fintech Fintech is the most important sector in VC investing. It alone is responsible for investments in excess of $20bn as of Q2 2022. However, it lost substantial relative importance to other sectors over the past year. Compared to last year, investments in fintech have fallen by 32%. Other important sectors, such as health have lost even more with a decline of 38%. The decline in health investments is more straightforward, as investments soared substantially while Covid-19 was “the topic”. With the current vaccines and it being more in the background, it receives less attention and with it less funding. The major profiteers from the past year are the energy sector which received more than the doubled amount of capital than in 2021. Figure 28 provides a breakdown of investments in the VC space. Fintech capital has soared by more than 100% in early 2021 and maintained this level throughout Q1 2021 with a peak of $35bn. These large values were largely achieved by investments of more than $250m. While other sizes of investments declined only slightly in Q2 2022, almost all the difference stems from the steep decline in very large investments. Within fintech, blockchain and crypto investments make up the largest individual portion in terms of the number of deals. Blockchain investments grew to 20% of all deals in fintech, which is a huge growth considering it only made up 2.5% in Q2 2020. The second most important area is WealthTech with a deal share of 15% and 18% of the total deal value. The area attracted $13.9bn in H1 2022. Other important areas that approximately all make up 10% of the deals are RegTech, Infrastructure and Enterprise Software, PayTech, marketplace lending, and PropTech. Figure 29 shows the entire breakdown by the number of deals in the fintech space. The effect of the current crisis on fintech VC exceeds the impact on VC as a whole. The most important development is a rapid decline in large deals, which is likely caused by increased caution with the short-term prospect of the industry and dropping valuations. Fintech valuations also dropped considerably more than the average VC investments. Exits also dropped considerably. During Q2-Q4 2021, IPOs were responsible for the lion’s share of exits in value of around $300bn over the three quarters. As a comparison, Q1 and Q2 IPOs very completely negligible and the total exit value just reached a bit more than $50bn. Investment growth in the subsectors strongly deviates. Figure 30 shows a breakdown of the decline in investments from Q2 2022 to the average in 2021. Payments, the major driver of fintech, is right in the middle with a loss of 23%. Crypto, DeFi, financial management solutions, and wealth management weathered the storm quite well with all of those categories being down 10% or less. The large declines in investments largely stem from banking, mortgages & lending, Insurtech, and Regtech, all of which lost more than 50%. It is also notable that none of its subcategories managed to achieve a growth in investments. Figure 28: Breakdown of VC Investments by Sector in Q2 2022, Source: Dealroom & ABN AMRO Ventures, July 2022 Figure 29: Global Fintech Deal Activity by Sector in H1 2022, Source: Fintech Global, July 2022 Figure 30: VC Investments by Subcategory in Q2 2022 Compared to the Average in 2021, Source: Dealroom & ABN AMRO Ventures, July 2022 Private Debt Private debt is decently well-placed in the current market environment. Bond yields are still relatively low from a historical perspective, but have seen substantial increases. This increase also spills over to private debt, making the current yields even higher. While this is favorable, the high inflation is likely to consume most, if not all, of these gains. In the current environment, achieving returns that are not real losses is already an achievement itself. Once the current inflation will start going down, interest rates are likely to be high for a while after that. In this ecosystem, the industry thrives. Thus, the industry will face some pressure in the very short term but is likely to benefit substantially after the initial storm has subsided. This rather bright outlook compared to most other investment strategies, also led to a solid performance and attraction from investors. Fundraising remains strong, as the current quarters are on similar levels than during the Covid-19 bull run. Figure 31 shows the quarterly fundraising of the industry over the past five years. In Q1 and Q2 2022, $40bn and $50bn were raised, which is on par with the best quarters the industry saw ahead of Covid-19. Some of this will certainly stem from the time lag of investment decisions and when the capital is actually flowing in. Compared to the last year, there have been some minor shifts in investor preferences. Most notably, investors plan to commit to funds in lower investment sizes. There has been a considerable shift to small investments at the expense of rather large investments between $100m and $300m. However, investments above $300m did not see a decrease. The US remains the most important market in the space with a market share between 60% and 70%. The remainder is largely split between Europe and Asia. However, there has been a significant increase in activities in the Middle East, and Southeast Asia, which will become larger and contribute further to the growth of the industry. The AuM of the industry recently surpassed the $1tn mark and is set to claim the $2tn mark within the next five years, according to Preqin. While this is quite likely, it is also dependent upon how the current crisis will turn out, and when it is resolved. Figure 31: Global Quarterly Private Debt Fundraising from Q1 2017 to Q2 2022, Source: Preqin Pro, July 2022 Real Estate The real estate industry had a tough time ever since Covid-19 emerged. Especially in 2020, it led to a substantial decline in interest in the industry. This was largely due to working from home and no travel. Offices and the leisure sector struggled massively, as their usage essentially dropped to zero for quite a while. 2021 managed to alleviate some pressure with the return the work and an increased amount of traveling. During this time logistics thrived and was responsible to offset some of the significant losses incurred by other sectors in the industry. In 2022, the Covid-19 imposed issues were largely resolved, baring specific countries that still impose major restrictions. The most notable geographies are China with its no-Covid policies, and Japan which is still closed to tourists. However, the current inflation poses other problems. As real estate is an illiquid market that relies on steady rents, it faces two issues. One treat is the potential of many tenants leaving as they cannot afford their housing anymore with rising prices across the board. Another treat is from the investors’ perspective who may struggle to achieve real income from their investments. The current crisis also provides some beneficial properties to the industry, as nearly every asset class is seeing losses, even if not adjusted for inflation. Alongside private debt, real estate provides a relatively steady income stream, which in turn makes it an attractive investment. Investors see the risk of issues in the space higher than its potential, as fundraising dropped substantially, especially in Q2 2022. This quarter is on par with Q3 2020 when the implications of Covid-19 became clearer for the industry, and the previously agreed capital flows started to run out. The last time the industry saw that little inflows was back in 2017. Given the current downward trajectory, it is unlikely that this trend will be resolved quickly. Figure 32 summarizes the findings on quarterly fundraising. Since 2019, the industry is seeing more problems to reach the target size of funds, which is visible in Figure 33. This trend strongly amplified in 2022, as only 30% of funds managed to reach their target size after 18 months. This is highly relevant, as before 2019, within the same time frame, it was usually 60% of funds. During the Covid years, this percentage dropped to 40%-50%. Figure 32: Global Quarterly Private Real Estate Fundraising from Q1 2017 to Q2 2022, Source: Preqin Pro, July 2022 Figure 33: Time Spent Until Private Real Estate Funds Closed After Launch, Source: Preqin Pro, July 2022 STONE MOUNTAIN CAPITAL Stone Mountain Capital is an advisory boutique established in 2012 and headquartered in London with offices Pfaeffikon in Switzerland, Dubai and Umm Al Quwain in United Arab Emirates. We are advising 30+ best in class single hedge fund and multi-strategy managers across equity, credit, and tactical trading (global macro, CTAs and volatility). In private assets, we advise 10+ sponsors and general partners across private equity, venture capital, private credit, real estate, capital relief trades (CRT) by structuring funding vehicles, rating advisory and private placements. As of 1st April 2022, Stone Mountain Capital has total alternative Assets under Advisory (AuA) of US$ 60.5 billion. 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