Private Equity Performance in Times of Crisis
As COVID-19 grips the world and with so much in flux, investors are trying to predict the impact this crisis will have on their portfolios.
PitchBook looked at historical data to examine how buyout funds specifically reacted during previous crises, including the Tech Bubble, 9/11, and the Global Financial Crisis (GFC).
Private Equity Tends to Be More Resilient than Public Equities, Especially More Mature Vintages
PitchBook’s research found that the magnitude of pricing swings was less severe with buyout funds than in public markets.
During each of the past two recessions, TVPI (Total Value to Paid In) fell to a lesser extent than public equity indices did. In the GFC, pooled TVPI dipped by 10% or less for vintages that were four years old or greater. Younger funds were more affected, with pooled TVPI declining nearly 20%. Funds eight to nine years old when the crisis struck were nearly flat. During the GFC, the S&P 500 fell by more than 50%.
Pooled TVPI by vintage cohort over time
Source: PitchBook | Geography: Global
Rolling pooled IRR by vintage cohort over time
Source: PitchBook | Geography: Global
Crisis-Era Vintages Typically Offer the Best Time to Invest in Private Equity Buyout Funds
With public markets falling through Q1 2020, PitchBook expects buyout funds to mark down portfolio companies in the coming quarters but to a lesser extent on average than their public counterparts. While this may keep LPs from selling at fire sale prices, many institutional investors are expected to be focused on triage in their current portfolios rather than on new fund commitments. However, according to PitchBook, this is a mistake.
As PitchBook's previous data illustrates, crisis-era vintages typically offer the best time to invest in buyout funds. Rather than holding steady or cutting exposure to equities—public or private—LPs should be allocating to the space.
2001 Vintage Funds Demonstrated the Best Private Equity Performance in the Past 20+ Years
This crisis may present opportunities for LPs that can act quickly and take advantage of the situation. CalSTRS has already confirmed they have cash to invest and will move quickly to take advantage of any opportunities.
Funds that did the bulk of their investing at lower prices in past downturns were able to record higher IRRs.
Although the recession did not bottom out until 2009, funds from 2008 also recorded similarly high IRRs, far exceeding 2005–2007 vintage funds. As we can see, 2001 vintage funds demonstrated the best private equity performance in the past 20+ years, and 2008-2009 vintage buyout funds were outperforming the vintage cohort preceding the global financial crisis (2005-2007) seven years in. For this reason, analysts at PitchBook believe that LPs should be heavily allocating to buyout funds at this time, even though they may be overweight because of drops in public equities. This is likely one of the better times in recent history to allocate to PE because GPs are investing at depressed prices; however, many LPs will be unable to move quickly enough to take advantage of it.
Pooled TVPI seven years since inception by vintage year
Source: PitchBook | Geography: Global
As of June 30, 2019
Pooled IRRs seven years since inception by vintage year
Source: PitchBook | Geography: Global
As of June 30, 2019
PE’s best returns tend to follow recessionary periods
Source: Pitchbook, Dealogic
Median IRRs for global buyout funds show relatively low private equity performance just prior to the 2000 and 2007 recessions, and stronger private equity performance during both recoveries as PE deployed capital in a lower valuation environment.
Private Equity’s Sophisticated Network of “Ready Capital” Creates an Edge in Crises
As the GFC began to unspool in the second half of 2008, pushing much of the global economy into decline, the media turned a spotlight on the “refi cliff” of more than US$570b in loans that PE portfolio companies needed to refinance. Credit agencies and others were pessimistic on the industry’s survival, predicting massive defaults. While a handful of defaults did occur, the doomsday scenario never came to pass. Empirical research provides insight into why this occurred.
One of the more widely cited papers by professors at Stanford Graduate School of Business and Kellogg School of Management looked into whether PE contributed to the economic fragility during this period. It found that PE-backed companies actually increased capex investment relative to their peers. At a time when many non-PE backed companies were financially constrained, PE’s access to capital – both from its own funds and from longstanding relationships with banks and other lenders – allowed PE firms to support companies in ways that others couldn’t, and possibly wouldn’t. The PE model appeared to provide additional flexibility and access to capital even during times of broad economic and financial market distress, an outcome that can reasonably play out once again.
The Result – a Test of the Model, and Newfound Appreciation for PE’s Resilience
As a result of coming out of the financial crisis, there was a newfound appreciation for some of the asset classes’ key advantages, including:
- Its ability to access long-term, locked-in institutional capital that positioned PE to be buyers of forced sales by asset managers such as mutual funds and banks who were pressured by their investors, depositors and regulators to redeem or optimize capital.
- The degree to which the greater alignment with investors, management teams and other stakeholders, and the relatively longer time horizons of PE investors, likely played an important role in enabling them to be more agile, and quickly and successfully respond to economic dislocation.
Wylie Fernyhough, a private equity analyst at PitchBook, noted that private equity performance is better in down or flat markets, compared with public equities, which thrive in bull runs. “If valuations begin to plateau across public and private, PE will likely outperform,” Fernyhough said.
Strong Era for Private Equity Performance Predicted
The current difficult market environment will create fertile ground for private equity and hedge funds to boost their performance, according to JPMorgan Asset Management.
Expected returns for cap-weighted private equity have risen to 9.80%, up 1 percentage point from the last forecasts issued Sept. 30, John Bilton, head of global multi-asset strategy, wrote in a note. The pandemic-induced market volatility “actually reinforces our conviction that there is a good medium-term outlook for alpha generation.”
“Dry powder on private equity balance sheets can be deployed now at lower entry multiples, broadly offsetting higher debt funding costs,” Bilton wrote.
Market Trend: Median and Average Private Equity Fund Size
After a record-setting effort in 2019, PE fundraising decelerated in 2020. Intriguingly, the median PE fund size increased even as the average slid steeply in 2020 through late May.
Unpacking this convergence, it’s clear that the largest, most established fund managers can bank on reputations and track records to close vehicles; it’s also likely that funds near to closing were able to conclude processes.
Median & average PE fund size ($M)
Source: PitchBook. As of May 21, 2020. Geography: North America and Europe
Source: PitchBook Q2 2020 Private Market Playbook, Analyst Insights
PitchBook analysts expect entrenched firms to have more success in fundraising, leading to more mega funds. The largest managers will tighten their grip on private capital markets during the coronavirus pandemic, according to PitchBook.
“Covid-19’s impact on in-person due diligence is thwarting fundraising attempts by nearly every GP and further exacerbating the bifurcation between mega-fund managers and everybody else,” Wylie Fernyhough, the senior analyst for private equity at PitchBook, wrote in a new report analyzing fundraising trends. “Business travel and in-person due diligence will likely be inadvisable for LPs for several months, meaning mega-funds and more established firms will continue to assume the lion’s share of capital.”
According to the report, private equity firms Thoma Bravo, Silver Lake Management, New Mountain Capital, and Francisco Partners have either launched mega-buyout funds — defined by PitchBook as vehicles targeting $5 billion or more — or are nearing first closes in spite of the coronavirus pandemic. Smaller firms, meanwhile, “have had to push out fundraising efforts indefinitely,” according to Fernyhough.
“The largest GPs are in high demand and able to secure fresh capital from LPs at a time when many smaller firms are unable to do so,” according to Wylie Fernyhough, Senior Analyst at PitchBook.
Private Equity Managers Eying Distressed Fund Assets
General partners say the coronavirus pandemic will cause a spike in demand for strategies targeting distressed assets.
Nearly all private equity managers expect to see a surge in distressed fund deals over the coming year, according to a new survey.
The poll, commissioned by fund service firm Intertrust Group, found that 92 percent of private equity professionals across North America, Europe, and Asia believe distressed fund activity will increase in the wake of the coronavirus pandemic, which devastated businesses in the U.S. and elsewhere. Likewise, private equity managers viewed distressed funds as the biggest fundraising opportunity in the near future, with 83 percent indicating there would be more investor demand for strategies targeting distressed assets.
This sentiment is already being borne out at major private equity firms. Last month, Apollo Global and KKR & Co. said they raised $1.75 billion and $4 billion, respectively, for credit funds focused on “dislocation” resulting from the Covid-19 crisis. Both funds were raised in just 8 weeks.
“Distressed-led activity is set to be a defining theme for the year, with the existing high levels of dry powder in the market expected to act as a catalyst for high-profile market transactions,” James Ferguson, head of Americas at Intertrust, said in a statement.
Other fundraising opportunities cited by survey respondents included specialist, sector-specific strategies — such as funds targeting healthcare or technology — and debt funds.
Where GPs See Fundraising Opportunities
Source: Institutional Investor, June 8 2020. Private Equity Managers Eying Distressed Funds, Private Debt
Manager Selection Matters
Fund-selection risk is measured by the dispersion in private equity performance between the top and bottom five percent of fund managers. During the 2008 financial crisis, the bottom 5 percent of funds “suffered a more significant loss” in their net asset values than the top performers, according to an article published recently in Institutional Investor. While the Covid-19 “shock” may not be “symmetric, it is reasonable to expect that the selection risk measure will increase.”
The importance of manager selection is especially acute in private equity where dispersion in manager performance is substantial. Manager selection and investment/operational due diligence are essential elements in managing private equity portfolios. The potential difference in outcomes is larger than in any other asset class. In private equity, it is the difference between meeting one’s return goals and falling short.
Effective private equity investors typically find that one of the best strategies is to focus on finding experienced managers who can take advantage of favorable investment conditions when they occur (effectively, buying low, selling higher, and taking advantage of secular growth along the way). It is also important that these managers have the networks, discipline, and industry expertise to potentially avoid overpaying in frothy markets, develop and execute clear value creation plans at portfolio companies, and identify some of the most accretive selling opportunities in any given market environment.
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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.