The global Covid-19 crisis has triggered the highest volatility seen in financial markets in a decade as the global economy faces a recession.
The last such situation (though not life-taking) was in the aftermath of the global financial crisis of 2008. And, given the reputation of private equity (PE) as a strong performer in the aftermath of the 2008 crisis, many investors have been seeking more exposure to PE asset class.
London-headquartered Preqin, a provider of data on investments in alternative assets, and FRG, a US-based risk management firm, highlight that the market upheaval caused by Covid-19 will reduce both capital calls and distributions in 2020, providing some leeway to investors facing an incipient short-term liquidity crisis.
However, Preqin and FRG say capital calls are set to spike in 2021, as fund managers take advantage of lower prices to acquire attractive opportunities.
Every crisis brings with it an opportunity, and the current pandemic is likely to be a boon for funds finishing their fundraising process and looking to deploy capital. In its previous research, Preqin had flagged concerns through its predictions suggesting that 2018/19 vintage funds would struggle to make satisfactory returns for investors, as they faced record high asset pricing and fierce competition. But under the new model, these vehicles will be ideally placed to acquire portfolio companies at the bottom of the pricing curve, once markets settle after the current volatility.
Covid-19 has suddenly turned the tables, as 2012-17 vintage funds are now set to see their returns depressed by the pandemic. Preqin says PE funds looking to make exits in the next 12-24 months will face a lower pricing environment, while vehicles currently operating their portfolios will see disruption to their holdings’ industries.
The recent vintages of 2016/17, which were bought at peak pricing and are now stuck because of the present situation, are likely to be most affected. Preqin further points out that collectively, 2012-17 vintages hold 77% of unrealised capital invested in private equity, suggesting the effect could be significant.
“Right now, people are primarily concerned with helping to combat the spread and mitigate the impact of the Covid-19 pandemic, as they should be,” says Dmitri Sedov, chief product and marketing officer at Preqin. “But in the coming months investors will have to look at the disruption in financial markets and ask if they are ideally positioned to achieve their investment goals,” Sedov adds. “Many have looked to private equity to help provide returns through good times and bad, and so the need to accurately predict their cash flows in this area is critical.”
On the other hand, FRG’s chief executive officer John Bell opines that cash flows from private capital portfolios are difficult to accurately model at the best of times. “But under certain economic scenarios an inaccurate forecast can adversely affect client portfolios,” says Bell.
The key question now is, how can managers optimise the performance of these investments? “It’s vital that they have the clearest possible picture of future cash flows, and their impact on the overall investment strategy,” says Bell.
The PE industry may not be immune to the current crisis, but since most are long-term bets, the imminent recession offers PE fund managers a record opportunity to buy at low prices after the longest bull market in recent financial history.
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