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Drawdown Risk
A lot of us have exposure to software/high-growth tech names that re-rated higher following the March 2020 crash and subsequent liquidity injection into financial markets. Most people relate this rise to lower interest rates, which benefit longer-duration assets. Let's frame this conversation under this context.

To be abundantly clear - I have no idea if rates will continue to rise, how fast they will rise, or what the impact will be on multiples/valuation. However, we can use a simple framework to understand the relative risk of these assets at current prices.

Let's start with relative valuations at today's prices. The chart here illustrates how high-growth SaaS (including DevOps and Data & Analytics companies) are trading relative to estimated forward sales. Think about this as growth-adjusted EV/S or PEG in EV/S form. Some of the best opportunities I see today like $ESTC $TWLO and $OKTA show up here.

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Taking one step back, let's see how a lot of these names have performed in past drawdowns. Specifically, what were the max drawdowns and associated recoveries during each cycle for many of these names? The included chart is a helpful visual to juxtapose these drawdowns to moves in the 10Y. H/T Wolfe Research
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Two quick takeaways:
  1. I can't help but notice the higher correlation between the 10Y and IGV in the more recent period compared to pre-2019. I haven't run real calculations but the visual is directionally helpful.
  2. If we are in another drawdown, we still have significant room to go. Coming into this week, the average drawdown was ~7% compared to 20% in prior cycles.

If the Fed cannot successfully disintermediate tapering from interest rate moves, we could still have some rocky months ahead as the market continues to handicap interest rate moves. But this is not a macro take - I want to now crosswalk to max potential drawdowns if we move to a multiple regime in-line with pre-COVID levels.

Below is an analysis comparing the current EV/S multiple against pre-COVID, post-COVID and historical (beginning 1/1/18) multiples - average, median, max, min. Additionally, the up/down skews are seen to the right. Negative percentages are downside, positive are upside from here.

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Key Takeaways:
  1. If multiples rerate to pre-COVID levels, most stocks could see severe declines and compression.
  2. Most of these names are well-positioned if multiples stay consistent with post-COVID levels.

So what? What do we do then? Well, I for one wouldn't be holding only SaaS / high-growth names. Plenty of companies offer attractive forward returns without the exorbitant drawdown risk. However, I would also try to understand how the highest quality names could perform through cycle / how fast these names could "grow into their multiples".

While I don't have all the answers, I wanted to assist your analytical efforts by providing the information.

How do you all think about SaaS exposure here given current market dynamics?

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