How can private equity investors ensure capital is put to work through the Covid-19 crisis?

Covid-19 has brought economies around the world to a standstill, and private equity deals have not been immune to the market slowdown. Global mergers and acquisitions (M&A) and private equity (PE) deal volumes have declined meaningfully in 2020, forcing investors to evaluate how to best allocate capital in an unprecedented market environment.

Consistent deployment of capital in private equity portfolios across market cycles is important, and a contributing factor in its strong long-term performance. Private equity often thrives in times of disruption, as it has the flexibility to take advantage of complex situations. Some of the best private equity vintages followed the global financial crisis (GFC) in 2008/2009, during which private equity funds deployed capital over the course of a cycle at relatively lower valuations.

If traditional private equity opportunities do not materialize in the near-term, what options do limited partners (LPs) have in putting capital to work?

Private equity alternatives in the current market environment

Private equity deal flow has been meaningfully impacted by the economic aftershocks following the pandemic lockdowns. Valuations are declining, M&A activity is stalling and the capital markets are tightening, causing general partners (GPs) and LPs to seek out alternative forms of capital to triage their portfolios.

Secondaries have proven to be a flexible capital provider across market cycles, and are well-positioned to take advantage of dislocations and liquidity requirements in the current environment. Dropping valuations result in more attractive entry points for investors, particularly secondary buyers who are purchasing off valuations from prior quarters. While secondary activity has slowed during H1 2020, due to the widening of bid-ask spread between buyers and sellers amid speculation on further portfolio write-downs and market volatility, the consensus is that volumes will rebound in the latter half of the year when those dynamics stabilize. Secondary investors then will be acquiring private equity portfolios at lower valuations, even if optical discounts end up inline with pre-crisis levels.

The slowdown in M&A activity will encourage GPs to seek out secondary solutions. Portfolio companies may require additional time and capital to re-grow, and secondary investors will structure GP-led transactions to provide that additional runway for a manager to maximize value across a given pool of assets. GPled opportunities have been the fastest growing segment of secondary volumes, and we expect this trend to continue in the current market environment.

The capital markets have yet to re-open fully, and the cost of any asset-level financings is currently high. GPs are turning to the secondary market to provide fund-level solutions, ranging from preferred equity structures to NAV facilities, depending on the risk profile, strategy and diversification of the portfolio. We have seen an uptick in these opportunities, which we expect to continue for the near-term. However, sponsors will eventually revert to raising traditional forms of financing via the capital markets when they become more accessible.

The landscape for secondaries, primaries and coinvestments has become more intermingled, and GPs have increasingly utilized all of these strategies to raise capital at the fund – and asset-levels. With a focused and proactive approach to deal sourcing, we believe there are opportunities which will provide different cash flow characteristics and ensure consistent deployment across market cycles.

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