Cambridge Associates’ Andrea Auerbach is tapping into her years of experience in private investing to navigate 2022’s choppy markets.
Looking to the most recent prolonged recession, the Global Financial Crisis, Auerbach said she sees some investors falling prey to the same pitfalls, while others have learned from past missteps.
“Those who ignore history are doomed to repeat it,” said Auerbach, partner and head of global private investments, during a recent interview. One parallel? In 2006 and 2007, private investment managers accelerated the pace of their fundraising and capital deployment.
That didn’t work then and is unlikely to now.
“We’ve watched some of the institutional investors follow right along,” Auerbach said. “The industry is about to relearn what happens when you do that.”
Auerbach spent four years in the private equity group of Prudential Financial, starting out as an analyst in leveraged buyouts in the 1990s. After a quick detour as an equity research associate at BMO Nesbitt Burns, Auerbach returned to the private markets — and Prudential — where she worked as a senior director for the private equity group until she left the firm for Cambridge in 2001.
She began her role as Cambridge’s head of private equity and venture capital research, then worked her way up to her current role.
In the early days of her career, Auerbach said private markets were made up almost entirely of leveraged buyouts and venture capital. Private credit was still dominated by banks and insurers, and mega-funds were considered those that had $500 million in assets — a small fund today.
Since then, the number of “active, separate, and distinct strategies has completely blossomed,” Auerbach said. Even specialized funds have narrowed their investment lens, focusing on consumer technology, for example, rather than tech broadly.
Investment managers have also become better at sourcing deals.
“It goes past having someone who has been through the past few cycles,” Auerbach said. “You want next-generation sourcing. It is no longer, ‘Let me call my network or go to the investment bank.’ You need to leverage everything you know.”
Before the GFC, annual returns for private investment firms were around 30 percent or higher, similar to where they are today. Peak to trough, according to Auerbach, the average swing was 18 percent. “You can’t take unrealized valuations to the bank,” she added.
Size also worked against good returns. According to Auerbach, when fund sizes doubled during the GFC, some allocators simply upsized their commitments to the fund. But those funds underperformed their peers significantly.
The buy-and-lever strategy is also dangerous. Instead, managers need to bring in expertise, strong operating partners, or talent development professionals.
“What we’ve learned coming through periods of economic stress is that the more you lever the company the more likely it is that you may lose some money on that investment,” Auerbach said.
That’s not to say that leverage is always a bad thing. “There are some private equity firms out there that are asking how much leverage they can get, then solve for how much equity they need,” Auerbach said. Instead, she added, they should be thinking about the right capital structure for the company.
Many investors have learned from past mistakes. “Here's a big lesson that I think the industry reminds itself of: I’m an LP,” Auerbach said. “I’m going to invest the right amount for me in any market environment. I'm going to maintain a steady investment pace.” Some investors didn’t have a choice. As they hit their allocation targets, they had to cut back, said the Cambridge partner.
Fundraising is slowing down in tandem. “It’s gotten real quiet. There are crickets chirping out there in the market,” Auerbach said.