Navigating the uncharted
In addition to the humanitarian crisis, efforts to contain and mitigate the COVID-19 outbreak have resulted in a historic stock market correction and seems to be leading the world into a global recession1. Implications for financial markets are wide ranging, and variables numerous, so that many investors do not even know which questions to ask, let alone what the answers they need might be.
The first and second order effects and the timeline of the crisis remain highly uncertain. However, our experience with two previous major crises - 2000-03 and 2008/09 - means we believe we can offer some insight on the risk and liquidity managemen issues institutional private equity investors may encounter in the coming weeks and months and can help them to navigate through this crisis.
We break down the implications for all of the following:
- Existing investments overall and by strategy, region and industry
- Cash flows (contributions, distributions)
- Reserves for follow-on financings
- ESG considerations
- Monitoring and risk management questions to ask
- Private equity allocations
- New investment opportunities
- Possible long term effects
Base case scenario: Several months of economic impact from lock-downs
The base case scenario underpinning our views is that lockdown measures - lasting up to several months – will have a significant economic impact. Although our views are subject to change, simply put, if the situation turns out to be less severe than we have assumed, everyone will express relief and will not regret, for having prepared for greater downside risks.
What can history teach us?
When searching for historic events that resemble the current crisis, 2008/09 seems to be a closer comparison than 2000-03.
Both now and in 2008/09, entire industries required a bailout. Banks, auto manufacturing and insurance firms required government intervention in 2008/09. Travel, mobility and hospitality firms (amongst others) are vulnerable today and will rely on government interventions.
In addition, fair market value accounting and mark-to-market rules (such as SFAS 157 in the US) were already largely in place for private equity during the 2008/09 crisis, but not yet in 2000-03.
Additionally, both in 2008 and in 2019, large buyout valuations and leverage levels were at high levels and fundraising was robust.
1 Schroders economic forecast, March 19, 2020: “Coronavirus to spark severe global recession”