Private Markets ‘Not Immune’ to Downturn

Private equity “will also certainly be challenged” in the economic fallout of the coronavirus outbreak, according to PitchBook.

Private equity funds may be safe from the daily turbulence of stock market volatility — but they won’t avoid the real economic impacts of the coronavirus pandemic, according to PitchBook.

The “genuine economic deterioration” resulting from government lockdowns and other containment efforts will hurt public and private companies alike, the data company said in an analyst note released late Monday. “Social distancing” policies intended to limit community spread of the virus, including shutdowns of “nonessential” businesses in parts of the U.S. and abroad, are expected to result in a decline in consumer spending and business investment over the coming months — a decline that will hit private equity portfolios, according to analysts Nizar Tarhuni, James Gelfer, Paul Condra, and Dylan Cox, who authored the note.

“A drop-off in the stock prices may or may not have a ripple effect on private equity depending on the underlying driver of that move, but a decline in the earnings profiles of those companies certainly poses risk to private equity as portfolio companies aren’t immune to the negative economic pressures that public companies face,” they wrote.

The analysts suggested that the slowdown in economic activity will “undoubtedly” cause a slowdown in private equity dealmaking. Deals that do occur will face tighter credit markets, and will therefore need to have “more conservative capital structures that include a larger equity proportion,” according to PitchBook. Still, the analysts argued that private equity firms are “better positioned to do that than ever before” thanks to the record amounts of dry powder, or uninvested capital, that they currently have in reserve. According to PitchBook, private investment vehicles currently have $2.4 trillion on hand to invest.

The analysts further argued that “well-funded” private equity vehicles “will be forced to inject more liquidity into portfolio companies, reducing the leverage that provides the enhanced returns” of leveraged buyout funds. Exit multiples are also likely to be brought down by an economic downturn, putting further pressure on the return profiles of private equity investments.

“We expect to see holding periods increase as firms will be forced to hold struggling assets and may find exit markets to be completely subdued for most assets,” the analysts wrote.

As far as how these trends will impact the overall returns of private equity funds, the PitchBook analysts suggested that performance is “largely baked in” for private equity funds raised in 2012 or earlier, and for venture capital funds dating back to at least 2010. Newly raised funds, however, will be the “most susceptible to long-term underperformance should a macroeconomic downturn ensure.”

Funds currently looking for investors are also likely to struggle in the near future. “For allocators to private funds, selloffs in public equities reduce the overall asset pool available for investment,” the PitchBook analysts wrote. Still, they suggested that this “denominator effect” will be mitigated by the fact that many limited partners are currently underinvested in private markets.

“While there may be a pullback in fundraising… we do not anticipate a dramatic downturn,” the analysts concluded.

Source: Institutional Investor

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