CapGen View: Private Equity

Private equity was not immune to the effects of a global economic shutdown, but given the time lag in terms of reporting, the initial signals took some time to surface. By June - July, GPs were able to give an initial steer as to their views on valuation, and in the main, funds generally trended down from 5% to 15%. It will come as no surprise that the worst hit sectors were those exposed to discretionary consumption, with retail and real estate heavy assets more exposed to the downturn than tech or essential services.

It’s worth noting however, that – particularly in intra-quarter updates – GPs have a fair amount of leeway in terms of how they want to express near term uncertainty in their valuations, so it will be some time before we see how well operating fundamentals truly recover. What I would highlight, is that we’ve seen good practice amongst our managers in terms of dealing with volatility; they have been proactive in communicating with investors in a timely, but still thoughtful and structured manner. As a general comment, the private equity industry has come on leaps and bounds in this respect over the last decade.

Distressed private assets can be a powerful addition to portfolios, but while you might imagine that this crisis would create these kinds of opportunities, so far this cycle has been quite different from the classic distressed playbook. A key reason is that this time around, central banks were swift, decisive and extensive in their actions to support the global economy, even more so than after the GFC. Furthermore, we have an environment of government mandated shutdowns alongside a state sanctioned regime of forbearance on enforcing creditor rights. What does that mean in practice? It means that the classical creative destruction wave is far more fragmented, where you have individual sectors splintering away in an alphabet soup of recovery shapes. Distressed is naturally appealing given the headlines that we read, but we are being measured and cautious in our approach here; there are quite a few unknowns in terms of what the new operating environment for companies and sectors will look like.

In terms of our own allocation, we have the benefit of having been investors in private equity for a long time. Over the past 13 years the focus of our strategy has remained the same; a core of well diversified, mid-market buyout exposure complemented by selected positions in large cap and growth opportunities. In terms of the pace of deployment; given that we entered the crisis with some dry powder on standby, we will be keeping our eyes open for opportunities, but as private equity funds typically have a three to five year horizon deployment phase, we don’t see a need to drastically change our commitment pace.

We think venture capital looks interesting at the moment and have been investing time analysing opportunities there. But in a broader sense an area that we like at the moment is where you see companies in a crossover stage; where they are growing so quickly that they can effectively leap from late stage venture capital to growth within the holding period of a single fund. So that’s an interesting area to mine; tapping into that growth inflection point. Last but not least, and tying into the point about distressed assets and creativity in the cycle, there are some interesting themes in secondaries at the moment.

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