May 11, 2020
Coronavirus May Be a Hit for 2018/2019 Private Equity Vintage Funds
Before the pandemic hit, forecasts suggested that 2018/19 vintage funds would likely struggle to make decent returns this year as they faced record high asset pricing and intense competition. But once the markets settle down from the current volatility, vintage funds will be ideally placed to acquire portfolio companies at the bottom of the pricing curve, according to research from financial data and information provider Preqin and risk management consulting firm FRG.2
While a recession certainly poses material risk to portfolio companies and exits today, it may also represent a record opportunity for fund managers to buy at low prices after the longest bull market in history.1
“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,” Dmitri Sedov, Preqin’s chief product and marketing officer, said in a statement. “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.”
Falling asset prices could mean that 2018 and 2019 vintages are more likely to outperform.2
Net IRR Range of Buyout Funds by Vintage Year: Baseline vs. Pandemic Scenario
Source: Preqin and FRG
For illustrative purposes only.
Using Preqin's Pandemic Scenario, the data shows that a downturn could have a significant positive impact on the performance of recent vintages. The Pandemic Scenario assumes a severe economic contraction of 20% in Q2 2020 real GDP, followed by a swift recovery in the remaining quarters of the year.
Sixty-two percent of buyout dry powder – valued at $815bn – is currently held in funds of vintages 2018-2019. As such, GPs managing these funds will have a substantial amount of financial firepower to put to work as asset prices fall.
At the same time, Preqin found that 76% of buyout unrealized value – valued at $1.22tn – sits in funds of vintages 2012-2017. GPs managing funds of earlier vintages may be faced with a challenging economic environment for their portfolio companies, as well as a more difficult market for exits.
While funds of vintages 2018-2019 generate a greater variation in returns compared to to Preqin's Baseline Scenario, a recession could mean an upward shift in median expected returns as dry powder is deployed at better prices.
Preqin's model indicates that in a recession scenario, funds of 2018 and 2019 vintages – viewed as the vintages most likely to underperform before the pandemic – are now more likely to outperform.
Most Attractive Sectors in the New Environment: Healthcare, Logistics, Software & Distressed Debt3
Sectors that Investors Plan to Target in 2020 Due to the Impact of COVID-19
Source: Preqin Investor Survey, April 2020
For Illustrative purposes only.
Private equity opportunities in non-cyclical sectors, particularly healthcare, are expected to grow, according to Preqin survey. Indeed, more than a third (36%) of investors surveyed in April 2020 said they planned to target healthcare-focused private equity in 2020, because of COVID-19. Healthtech – a fast-growing industry highlighted in the 2020 Preqin Global Private Equity & Venture Capital Report – is likely to attract more investment, with demand for telehealth solutions increasing due to social distancing. Given that healthtech is a relatively young sector, there is likely to be a higher volume of deals in the venture capital space. In 2019, 1,000 venture capital deals were completed in healthtech, an 18% jump from 2018.
The technology sector could benefit as digital transformation becomes even more business critical. In a lockdown situation where remote working is a requirement rather than an option, demand for digital technologies such as cloud computing services and cybersecurity is likely to soar, according to Preqin.
According to S&P Global Ratings, a surge in defaults is likely as a result of the pandemic. The default rate on US nonfinancial corporates could rise above 10% within the next 12 months, up from 3.2% as of February 2020, the credit ratings agency said. A surge in defaults would create opportunities for distressed debt funds. More than a third (35%) of investors said they expect to target distressed debt opportunities in 2020 as a result of COVID-19. Managers specializing in this strategy will be on the hunt for fresh capital, according to Preqin.
Demand for logistics assets, especially last-mile distribution, has been soaring, driven by trends such as the rise in e-commerce. It will be difficult to top Blackstone’s $18.7bn acquisition of Singapore based GLP’s US logistics portfolio, the largest-ever private equity real estate deal. But with dry powder at $344bn, and a growing need for efficient distribution systems, the logistics sector may continue to drive deal activity, according to Preqin.
Alternative Investments Have Doubled their Share of global Investible Markets4
According to CAIA, trends are showing increasing portfolio diversification as investors move from domestic to global portfolios and allocate from traditional investments towards alternative investments.
Fifteen years ago, alternative investments comprised 6% of the $4.8 trillion global investible market. Today, the global market totals $102.6 trillion, while alternative investments have grown to $13.4 trillion or 12% of the global investable market, with retail investors averaging allocations of 5% and institutional investors having substantially higher allocations.
Percentage of Global Investible Market
*Assets as indicated in the GIM chart
Global Investible Market (in $Trillions)
Projected Directional Change Over the Next 5 Years
Source: CAIA. The Next Decade of Alternative Investments.
For informational purposes only.
PE Allocations to Rise, but Performance Varies Widely by Manager4
As capital continues this migration, manager due diligence and performance dispersion are important considerations. CAIA data illustrates top quartile PE managers can outperform bottom quartile managers by 10 to 20 percentage points per year, while the median manager in any given year may have returns like public market indices. Avoiding the underperforming managers is key to generating private equity portfolio returns exceeding public market returns. But, of course, not everyone will be above average.
Average, Top Quartile, Bottom Quartile Performance of Managers
Source: CAIA Association, JP Morgan, Preqin, CISDM
For illustrative purposes only.
Market volatility creates private equity opportunities over the long-term, and this may be the opportune time to consider the asset class. When it comes to private equity investing, manager selection can be the difference between meeting your clients' return goals and falling short.
- Chief Investment Officer. Coronavirus a Boon for 2018/2019 Private Equity Vintage Funds. April 6, 2020.
- Preqin. How a COVID-19 Recession Is Likely to Affect Buyout Performance. March 31,2020
- Preqin. Preqin's House View: COVID-19's Impact on Alternative Assets. April 29,2020
- CAIA. The Next Decade of Alternative Investments.
DISCLAIMER: This industry information and its importance is an opinion only and should not be relied upon as the only important information available. No representation is being made that any investment will or is likely to achieve profits or losses similar to those shown or described. Performance will vary based on many factors, including, but not limited to, investment strategies, taxes, market conditions, and applicable advisory and other fees and expenses related to investing.