Three Things (7/26)

Continuation funds in PE

Many private equity managers are in a time crunch to deliver returns to investors by hitting the J curve, or entering profitability after a period of expensive initial investments. Given the higher rate environment has been challenging for PE managers, continuation funds are one of the tactics used to avoid selling investments and instead roll the capital into a second fund. PE managers claim they can maximize returns over the long haul using continuation funds, but realistically they are delaying the return of capital to investors during a weaker deal market.

As one might expect, continuation funds are not met without pushback – many feel the concept of rolling capital into a new fund with add-on fees and carried interest seems to reward managers for not getting their job done. It wouldn’t be surprising if continuation funds faded out due to investor pushback, increased regulations, or a better deal market given lower interest rates. Fast forward 10 years from now, and we wonder if they might be viewed in the same way SPACs are today.

Lineage IPO

Lineage, a temperature-controlled warehouse REIT, made its debut to public markets on Thursday as the largest IPO of 2024. Lineage has two in-house software solutions: Lineage Link, a customer experience platform for active inventory management, and LinOS, a warehouse execution system that increases labor productivity. Since 2019 the company has invested $725 million into technology and artificial intelligence, and they’ve created a custom AI/ML solution that automates cooling to reduce spoilage and maximize cost savings.

It’s refreshing to see a non-tech company insert artificial intelligence into antiquated processes at a time when the AI focus is largely on LLM companies. Lineage’s data science team uses weather forecasting and seasonal patterns to cool facilities more sustainably. They’ve also reduced labor costs to 60% of their cost structure by combining different customers' inventory with similar routes onto fewer trucks. There’s no doubt that Lineage is a bright spot in a rather dull IPO year, and its success is warranted given it’s made dramatic strides in an industry that had been largely untouched by AI.

GDP perpetuates the small cap rally

Gross domestic product grew at a faster rate of 2.8% in the second quarter compared to the first quarter at 1.4%. That being said, GDP growth did slow last quarter compared to a year prior, and inflation has continued to cool. At first glance, the economy appears stronger than we expected, which could conjure up fear that interest rate cuts may be delayed even further. On the contrary, the market was glad to see continued year-over-year growth slowed to a point that still makes a soft landing scenario seem in reach.

Investors are still anticipating an initial rate cut in September, and the GDP print only perpetuated the rotation of funds from large-cap tech companies to small cap companies that could benefit from a lower interest rate environment. In order for the small cap trade to continue, the data will need to continue to straddle the balance of showing that restrictive policy has done its job without pushing the economy too far into recessionary waters, which would hurt small cap companies most of all.

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