Many private capital firms are looking to learn more about how the COVID-19 pandemic is affecting their portfolios and to find out how others in the market are responding. Recently we had virtual conversations with several leading private capital companies, limited partners and industry stakeholders to gather insight into what is happening and what’s coming next.
Many of the executives were immersed in two exercises:
Many executives are also examining government policy directives to ensure that private equity portfolio companies can take advantage of the available safety nets. Many executives expressed the need for additional clarity and output from government schemes.
While the exit window is closed and fundraising will be a challenge for specific strategies, other strategies can fare well in any displacement scenario, including the present environment. Past performance shows the private equity industry has been relatively resilient during market downturns. While today’s playbook looks quite different, we can assess lessons learned and adapt. For example, the rise in demand for co-investments—as appetite for blind pool risk has declined—is an important outcome of the evolution of this industry.
Despite prior market downturns, the private equity industry has returned 7.5x invested capital in this century alone. This proven track record keeps private equity ahead of other asset classes.
The ability for private equity to bounce back from the current environment is based on its underlying dynamics—i.e., more nuanced economic mark to market implications, and buy-to-hold underlying assets. While valuations will see a downward adjustment in the coming quarters, managers can sustain portfolio companies and help them weather the storm through financial re-engineering, government support and provision of working capital. Also, as we think about the future, there is a dry powder available for acquisitions at attractive valuations.
We also see an increase in Private Equity Investing in Public Equities (PIPE) transactions. With precipitously low valuations, there will be attractive opportunities for private equity firms. There will be chances to take a foothold in public companies without attempting to take any business private. As the market rebounds, so could the controlling stakes in these businesses.
Some firms are calling capital more rapidly than initially planned, and some may draw down capital call facilities to mitigate short-term financing bottlenecks or to fund acquisitions. As managers make decisions with incomplete data in an ever-evolving situation, they need to be mindful of future scrutiny on current choices.
The current environment could lead to a rise in secondary transactions. We spoke to one of the leading players in this space and he noted that an increase did not happen in the 2008 market crash. Instead, LPs held onto their positions rather than off-loading them at below-market prices. There is no textbook on the trajectory or resulting trends from a crisis. Each crisis charts its own path.
The evolving situation and opinion will continue to change based on a variety of factors. There is no doubt banks are better prepared to weather the storm. There are counter-cyclical buffers in place, a decade of stress-testing and the central bank is pumping more liquidity into the market. While this will be a challenging 12-18 months, overall balance sheet strength and better preparedness are cause for longer-term optimism.