By Sean Thompson, Managing Director, CAMRADATA
The uncertainty in the markets and fears of a global recession due to the Coronavirus crisis has left many investors wary. However, following some inevitable disruption in the shorter term, investors and asset managers[i] who attended our recent Private Markets roundtable considered the potential for investments in private markets.
Looking back to 2019, private equity in Europe had another vintage year. Investments reached a record €94bn – a 10% increase compared with 2018, according to trade body Invest Europe.
The experts noted that similar results can be expected for other private markets investments, such as private debt, which over recent years has grown to partly replace vanilla fixed income allocations in institutional portfolios.
In the previous 12 months that led to the record level of private equity investments, the term ‘Peak PE’ was created, the notion being that the top of the market had been reached after a decade which saw money flooding private markets, as investors incessantly chased higher yields and diversification, while interest rates remained chronically low.
It wasn’t only private equity that experienced these peaks. ‘Peak Everything’ appeared to be a natural result of a record-long business cycle propped up by emergency economic measures.
However, a poll by fund administrator Intertrust, which was carried out at one of the firm’s events, found that 46% of private equity professionals cited that the availability of attractive assets at lower prices would be a key driver shaping their 2020 activities.
Even though fund raising is predicted to be difficult, general partners appear keen to acquire new investments at lower valuations resulting from the Covid situation. This being the case, investors could still ask if ‘Peak PE’ really has been reached and if another record can be achieved as private capital responds to the Covid crisis.
The path ahead
While the roundtable guests said they didn’t know the exact path of economic recovery, nor the socio-economic consequences of a substantial rise in viral infections, they discussed the scenario-planning they had been doing.
They had looked at scenarios such as there being a deep recession in Q2, a modest recession in Q3 and a slow recovery starting in Q4 and subsequently categorising borrowers into three buckets: Type 1 companies have a low correlation to the impact of COVID-19, type 2 will not see an immediate revenue impact from the virus and type 3 will see an immediate revenue impact.
Since doing this several companies have had to be reclassified because of the more severe impact and duration of COVID-19.
The investors stressed that we are very early into this crisis. And private markets managers get paid on deployment, not commitment. In other words, with a weight of money looking for a home, could managers feel beholden to deploy regardless of lack of visibility?
Regarding revenue visibility, some investors said they have avoided sectors such as airlines and restaurants. Instead, they have looked for businesses in Type 1 “relatively immune” category, such as a salt mine company. As one expert said, “We are going to salt our roads this winter; we all need salt on the table at dinner,”
Looking at trade finance, some investors see possibilities for this kind of debt as a way to earn an interim return while looking for more illiquid opportunities. In an era where yields on money market funds and debt all the way out to fifty years have eroded to unprecedented lows, alternatives of all sorts come into consideration.
One example is insurers, whose general funds need higher returns than the conventional fixed income offered. However, several ‘higher yield’ trade finance funds had run into difficulties recently, involving defaults in some cases but also large withdrawals leading to the unexpected return of capital to investors.
It was also noted that smaller pension funds would typically have neither the scale nor the governance necessary to access niche parts of the market like trade finance directly but there are multi-strategy funds that can include an allocation to it as part of a basket of private credit strategies.
Data from the US Bureau of Labor Statistics show that between March and April, unemployment leapt from 4.4% of the population to 14.7%. Add in those temporarily laid off and the figure got close to 30m people. In May, however, over two million people found new jobs – wrong footing many economists.
A rise in employment is cause for relief if not celebration, but one panellist described the trillions of dollars in Quantitative Easing that helped this recovery as “historic”. They noted it dwarfed relief during the Global Financial Crisis.
Many private markets managers have never lived through a downturn, so this year is going to be a good test of their underwriting skills. And while unemployment data appears monthly, some of the experts said that it wouldn’t be until December, when data for Q3 arrives, that asset owners and Limited Partners such as the Nationwide Pension Fund, get a real sense of what losses their borrowers have suffered under lockdown.
The final advice from the experts at the roundtable was that investors should keep steady and commit through the cycle: private markets was not an area that suited tactical entry and exit, not least because of the time periods between commitment and deployment.