In 2019, global private assets under management reached USD 6 trillion as growth in private markets overtook that of public markets. Private markets have delivered high absolute returns, driving up demand from high net worth and institutional investors.
With public equity markets in tailspin as economies shut down to contain the coronavirus, will private equity markets share the same fate?
Overall, private-market valuation write-downs can be expected for some companies as early as the first quarter of this year, reflecting 2020 performance uncertainty and the devaluation of equity markets. On the transactions side, even while record transactions are being executed, some are being delayed or aborted by the application of material adverse change clauses.
Looking ahead, and while each new crisis carries its share of uncertainties and turmoil, history has shown that market dislocations and sharp asset price corrections create investment opportunities: recession years tend to generate superior returns for the private equity asset class as a whole.
“Recession years tend to generate superior returns for the private equity asset class as a whole.”
What asset-class specific risks does private equity face now?
Private-equity managers are currently assessing the immediate and potential future impact of the coronavirus outbreak on their portfolios on a company-by-company basis. Businesses are facing two key areas of risk: operational, which encompasses the negative impact on revenues, EBITDA or supply chain disruptions or financing, which translates into near-term liquidity difficulties or covenant concerns.
Companies exposed to travel, leisure, entertainment, corporate events and the energy sector face the highest operational risk. Private equity managers are currently working to implement protective actions wherever possible to address the operational risks identified.
The potential financing risk is assessed by the ability of capital structures to withstand a period of underperformance, carefully looking at the availability of liquidity, covenant headroom over the next six to 12 months and upcoming debt maturities. Thankfully, for the past few years, debt has been cheap and accessible, often available with no or few covenants, thus offering more headroom and reducing the burden on companies’ cashflows and default risk. At this stage, it seems that only a minority of companies face financing problems. For those few companies anticipating short-term liquidity issues or covenant breaches, private-equity managers are proactively working with lenders to address those matters.
How do you expect real estate assets to fare in the current environment?
While we expect the real estate space to experience adverse impacts from the Covid-19 crisis, the effects will likely be varied across property types and assets. Stabilised assets with established, longer-duration lease terms in place and "essential" live/work property types such as multi-family, logistics and offices should fare relatively well, at least over the near term.
Other sub sectors like hotels and retail, whose business models face either secular or cyclical challenges, will suffer from the current dislocation. On the other hand, the recent decline in interest rates should provide some positive relief, having been historically conducive to price appreciation in property markets.
“The performance of private assets is intrinsically linked to the advantages of active ownership.”
Everyone talks about the explosive growth in passive investing, but is private-asset investing the real dark horse in terms of asset growth?
Indeed, private markets — composed of private equity, real estate, private debt, infrastructure and natural resources — are growing at twice the rate of ETFs, having tripled in assets under management over the last decade since the financial crisis. And there is a deeper point of comparison — or rather contrast — between passive and private asset investing. The performance of private assets is intrinsically linked to the advantages of active ownership. Notably, private ownership enables asset improvement through aligned incentives and flexible governance, and asset improvement directly creates value. In private equity today, asset improvement accounts for around 60% of its internal rate of return (IRR1).
Beyond the current crisis, what are the key long-term industry trends and changes that you anticipate will impact private assets? There are five areas of change that we are focused on that are already underway.
First is the broad expansion of private assets as companies remain private for longer and public companies delisting to go private are on the rise. Both private equity and infrastructure are asset classes in need of investment and this is where we see opportunities to create value as likely to grow.
The second is investor democratisation, with an increasing share of individual investors accessing private assets through intermediaries such as private banks, pensions, etc.
Third is tech disruption across the value chain, from deal sourcing to investment analysis through to client engagement, the automation of operations and beyond. In the real-estate sector, the disruption of e-commerce in retail could create attractive opportunities in logistics and data centres.
Fourth is the rise of Asia over the next five years, from both a fundraising perspective as well as an investment destination. Rising wealth and development in the region will make it increasingly central to the private asset industry.
And finally is the growing demand for sustainable investments. Indeed, today impact investing is predominantly in the private equity space and expected to reach 10% of private equity assets under management this year. Since 2017, the world’s largest private-equity funds have all launched responsible investing products. With Millennials twice as likely as the rest of the population to buy products from sustainable companies, as they inherit and increasingly create their own wealth, we can expect momentum growth behind this trend.