After two years of frenetic activity in venture capital, sovereign wealth funds and public pension funds have stepped on the brakes as the effects of the Ukraine crisis threaten to upset the post-pandemic recovery.

Global SWF data shows that in the first half of this year, private equity investments soared past US$50 billion, indicating 2022 could be a record year and will top the US$74 billion recorded in 2021. Yet, as a proportion of the total, venture capital in H1 was just 10% of the total, down from 25% for 2021. The database reveals 125 transactions, of which 40% were in the first two months of the year and before Russia’s invasion of Ukraine; this compares to a volume of VC transactions of around 340 in 2021, indicating the pace has slackened.

The decline comes after a bull run for VC, which saw an explosion of unicorns, many supported by state-owned investors. Valuations are at all-time highs in 2021 encouraged by a fast pace of exits and strong liquidity potential, including IPOs and SPACs. The potential for the bubble to burst has always remained high and Global SWF’s 2022 Annual Report outlines some risks, such as over-priced assets, regulatory pressures, and public market volatility. But nothing prepared the world for a major military conflagration in Europe that has left energy markets in turmoil and fuelled inflation.

While the pandemic hastened the pace of innovation and influenced consumption patterns that provided new investment opportunities, the latest crisis has left state-owned investors with few options. The pool of sovereign capital is rapidly drying up as valuations are compressed in private markets, while declining tech stocks leave few opportunities for lucrative exit. The worst aspect of the outlook is that there is no sign of any bottoming out while global inflation soars.

The collapse in IPOs has also seen a drop in crossover rounds, the large financings ahead of floatation. Private companies that are unable to turn to public markets for cash are resorting to further financing rounds at lower valuations, undermining the values of venture capital portfolios. The hiking of interest rates is merely adding further stress to private markets.

It seems almost inevitable that cash will gravitate to relative safe havens. Global SWF research finds one stand-out trend: slashed funding for VC in the retail and consumer space, which includes e-commerce, while financial services, including fintech, held their own. Technology, Media & Telecommunication (TMT) and healthcare declined slightly in the sectoral allocation, while industry and manufacturing startups increased in importance. In the fintech sector, sovereign investors were attracted to specific areas, such as electronic payments, lending platforms and insurtech, which they see as benefitting from the cost of living crisis in developed markets.

While the situation facing VC in 2022 is not yet comparable to the collapse of the dotcom boom, the current perfect storm of crises has dealt a blow to funding in private markets and sovereign investors are set to become far more discriminating in what they pick. The days of private markets being awash with liquidity are coming to an end – and sovereign investors would well benefit due to fewer competitors and lower values, which offer potentially bigger rewards, whenever the world decides to calm down.

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