Coronavirus Set to Shake Up Private Equity Performance
by: Mark Heschmeyer | CoStar News | April 9, 2020
The global coronavirus health crisis that has prompted extreme market volatility has reversed the outlook for private equity funds formed in the past two years. Like fine wines, 2018-2019 could be the preferred vintage.
These funds may be well positioned to acquire companies at lower prices once markets settle, according to new research from alternate asset information and analysis provider Preqin and the risk-management firm FRG. That's a switch from previous predictions suggesting funds formed in 2018 and 2019 would struggle to make satisfactory returns for investors because they faced record-high asset pricing and fierce competition.
Conversely, older funds formed from 2012 to 2017 are set to see their returns depressed by the pandemic. Funds looking to sell in the next 12 to 24 months could be facing a lower pricing environment, while those currently operating their portfolios could see disruption to their holdings' industries.
Funds started in 2016 and 2017 are likely to be most affected, having been bought at the pricing peak and potentially being unable to recoup investments through asset sales.
The dynamics are important because many investors piled into private equity and hedge funds as the downturn loomed, hoping to capitalize on a repeat of the strong performance these alternative asset managers achieved in the aftermath of the Great Recession. The new research suggests there will be winners and losers.
Private equity funds raised a record $51 billion last year, Rahmin Maali, associate vice president of private capital for Preqin, told CoStar in an interview. The top five funds that closed last year were raising money to take advantage of a downturn. Three of them were opportunistic funds seeking to turn around low-performing properties: One was for investing in distressed properties and one was for investing in nonperforming loan debt.
The pandemic has made this an opportune time for those funds, according to Maali.
"We’ve already started to see some big valuation write-downs across the globe for big firms," he said. "So we would not be surprised to see the firms with capital start circling."
The consensus outlook suggests the growing opportunity for deals could spur more fundraising interest and deal activity, he added.
"I think in time we may get up to similar levels of funds raised as in the first quarter of 2019 this quarter, but I wouldn’t expect us to get near the $51 billion for the year," Maali said.
That has more to do with the fact that the funds currently in the market are targeting smaller totals than a couple of mega-sized funds that closed last year, he said.
In addition to fundraising and deal activity, the research from Preqin and FRG suggests that market upheaval will reduce both calls for committed capital and distributions in 2020. However, capital calls are likely to spike in 2021, as fund managers take advantage of lower prices to acquire attractive opportunities.
The research anticipates that 2017-2019 funds will reduce capital calls by 38% and reduce distributions by 19%.
"This is because we expect deal activity to be muted and distributions delayed as [general partners] looking to buy wait for valuations to fall and greater economic certainty," Jonathon Furer, head of strategy at Preqin, wrote in the analysis. "At the same time, [general partners] that would otherwise look for an exit hold on to their assets to avoid selling in a downturn."
Particularly striking is the sharp reduction in capital calls for funds with the highest amounts of dry powder.
"This should offer some relief to [limited partners] that are considering how they would meet their obligations in a more challenging environment," Furer wrote. "That said, investors should also plan for how they will meet outsized capital calls in 2021, as fund managers ramp up capital calls to capitalize on the lower asset prices."
Until the coronavirus outbreak emerged at the start of this year, private equity fund managers consistently cited high asset prices as the main threat to returns, Furer said. Now with prices on a downward trajectory, fund managers are likely to be able to pick up assets at significantly reduced prices, thereby boosting returns.