StepStone Group, the private markets investment powerhouse, just released their Q4 2024 earnings transcript, and on the surface, everything seems rosy. Record fundraising, accelerating growth, expanding margins – it's a symphony of success. But beneath the triumphant melody, a subtle shift in the rhythm hints at a potentially seismic event brewing in the private markets.

The clue lies in StepStone's Undeployed Fee Earning Capital (UFEC), a metric reflecting capital committed but not yet generating fees. It currently stands at a staggering $22.6 billion, a record high fueled by a $12 billion surge in the last six months alone. This unprecedented UFEC buildup, primarily driven by managed account re-ups, points to an LP community brimming with dry powder, eager to dive into private markets.

While this might appear as a bullish signal, a closer look reveals a potential double-edged sword. The surge in UFEC coincides with a still-sluggish deployment environment. Scott Hart, StepStone's CEO, highlighted a "slight pickup" in new investment activity, but acknowledged that deal flow remains "somewhat depressed."

Here's the catch: if deployment doesn't accelerate in tandem with this mounting UFEC, we could be on the verge of a private market investment tsunami. Imagine billions of dollars suddenly flooding a market still recovering from a deal-making drought. It could lead to inflated valuations, intensified competition for assets, and potentially, a squeeze on returns.

StepStone's own calculations suggest a potential bottleneck. They deployed $1.3 billion of UFEC in Q4, translating to an annualized run rate of just over $5 billion. With over $20 billion of deployable UFEC, even this accelerated pace implies a four-year deployment timeframe, right in the middle of their historical three to five year range.

However, this calculation doesn't factor in the $3.3 billion from the recently activated venture capital secondaries fund. Adding this to the mix pushes the deployment timeframe closer to five years, assuming a constant deployment rate. The question then becomes, can StepStone maintain or even exceed this pace in the face of increased competition from other players also grappling with their own UFEC mountains?

This potential deployment gap is not just a StepStone-specific concern. It reflects a broader trend across the private markets landscape. Preqin data reveals a record $3.7 trillion in global private capital dry powder as of Q3 2023, waiting to be unleashed.

StepStone's unique position as a multi-asset class solutions provider with insights across a vast swathe of the private markets gives them a front-row seat to this brewing storm. Their success in attracting significant re-ups from their managed account clients, even during a challenging fundraising environment, testifies to their strong reputation and LP confidence.

But the growing UFEC also serves as a canary in the coal mine, a whisper in the numbers hinting at a potential surge in private market activity. The key question remains: will deployment keep pace, or will we witness a private market tsunami, reshaping the investment landscape in ways we can only begin to imagine?

Hypothesis: Deployment Lag and Its Impact on StepStone

StepStone's sustained success in fundraising, particularly in managed accounts, will continue to drive UFEC growth in fiscal 2025. However, deployment will lag behind, pushing the average deployment timeframe beyond the five-year mark. This will result in a temporary dip in fee-earning AUM growth and potentially put pressure on margins, as the firm incurs costs associated with managing this growing pool of capital yet to generate fees.

Further, the potential for a buy-in of remaining ownership in their infrastructure business, potentially stretching over 15 years, could add another layer of complexity to the financial picture. While designed to be accretive, the impact on share count and earnings dilution needs to be carefully evaluated alongside the pace of infrastructure AUM growth.

StepStone's journey is one to watch closely. It's a story about navigating the choppy waters of a shifting private market landscape, balancing the influx of LP capital with a measured approach to deployment. Their success in this balancing act will not only determine their own fate, but also offer valuable insights into the future dynamics of the private markets as a whole.

StepStone's Fee Earning AUM Growth and Undeployed Fee Earning Capital

The table below shows StepStone's Fee Earning AUM and UFEC for the past two quarters, highlighting the rapid growth of undeployed capital.

UFEC Deployment vs. Accumulation

The following chart illustrates the potential disparity between StepStone's UFEC accumulation and deployment, based on their Q4 deployment rate and factoring in the newly activated venture capital fund.

"Fun Fact: The term "dry powder" in the investment world refers to capital that is readily available for investment. StepStone's massive UFEC stockpile indicates a significant amount of dry powder waiting to be deployed in the private markets, potentially leading to a surge in investment activity."