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Here’s what the stats say about LP and GP activity during the coronavirus

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The impact of the coronavirus crisis is likely to be felt around the world for years to come, with the economic aftermath potentially outstripping the 2008 financial crash. And that uncertainty over how the future is going to play out could easily see LPs becoming less trigger happy with capital, and private equity firms entrenching into safer investments.

If the recent findings of a survey from Cebile Capital are to believed, LPs are expecting to be more hesitant in deploying their capital. The survey claims that two-thirds of limited partners are expecting to miss their deployment targets for 2020. Cebile Capital got responses from a host of institutional investors, with a collective AUM of $425bn. Nearly 70% of LPs reported this slower deployment was down to a more selective approach for allocations and an increased due diligence scrutiny. The most appealing thing to LPs currently is with managers that have demonstrated the ability to protect capital and add value during volatile market conditions.

That said, LPs are not letting the current environment hamper their optimism. The report claims that 85% of investors are expecting to either maintain or increase their 2021 private equity budgets.  Cebile managing partner Sunaina Sinha said, “What’s important to note is that LPs continue to trust in private equity, with 35% of respondents expecting to increase their private equity commitments in 2021. And although they expressed uncertainty over the lifting of lockdown measures, they did not expect this to be an operational issue 12 months from now.”

Defensive investments could see a rise in popularity over the coming year to try and bring some stability to portfolios. A white paper from Foresight Group’s Stability in Adversity shows that more than half of financial intermediaries are seeing infrastructure investments becoming a much more common sight. This increased exposure to infrastructure investments could be around for three years. The reason for the popularity in infrastructure is its low correlation to traditional assets (73%), defensive qualities (66%) and low volatility (58%). Of the respondents, 75% claimed they are likely to use infrastructure assets to compliment their traditional equity income so they can access sustainable income during the uncertain financial market.

With LPs looking for the safest investments at the moment, a survey from placement agent and fund advisory firm Eaton Partners, claimed over half of respondents were focused on infrastructure investments for the next year. Other areas of high-demand are data/tech and ESG/renewables strategies in greatest demand. Almost two-thirds of respondents (62%) believe there will be an elevated interest in asset-backed strategies this year. When looking what private markets to back, it appears private equity is still the most popular with it being the preferred area for 45% of respondents. It is followed by private credit trailed at 27% and hedge funds at 17%.

A denominator effect

One of the initial fears plaguing the investment industry when the sheer scale of the pandemic was being realised, was that of the ‘denominator effect.’ This is where a limited partner becomes over allocated within their private equity or private market portfolios due to the decline in valuations of their public portfolios. This marks a problem for private equity as an LP may aim to reduce its allocation percentage to private equity by not contributing to new funds or asking the GP to hold back on making investments to stop the frequency of capital calls. Even more troublesome could be an LP default. This is where they refuse to meet the capital call. These LP defaults were expected to be a common predicament, but it has not come true, according to PitchBook’s Q1 2020 Private Fund Strategies Report. It claims that several LPs came forward to GPs in March in regard to paying off subscription lines of credit, but acute liquidity issues have not been a widespread issue.

The report said, “A few LP defaults have been reported from small non-institutional investors, some of whom have since been able to settle up with their GPs. We expect capital calls to fall after this initial wave as GPs spend time shoring up portfolio companies rather than closing on new deals, which should ease any strain LPs may have felt. Deal activity at both the primary and secondary levels has ground to a halt as market participants take some time to recalibrate what companies or LP stakes are now worth.”

There was a denominator effect in the fallout of the global financial crisis in 2008, but Pitchbook believes the market is not seeing something on the same scale due to LPs being typically under allocated in private markets currently. LPs are quite aware the denominator effect may have been exaggerated. The previously mentioned survey from Eaton Partners claimed that 55% of its LP respondents were not worried about the effect and around half have not seen noticeable changes to capital calls. Furthermore, 56% said they are not facing liquidity issues.

Fundraising and dealmaking

With the financial market being unpredictable at the moment and difficulty in seeing how industries will be impacted, questions are raised on whether LPs will commit capital to funds. In the survey from Eaton Partners, it claimed in April, two-thirds of institutional investors said they were not planning to change their private market portfolios. However, a subsequent survey from the firm in May showed this dropped to 51%. Of the respondents, 26% claimed they were looking to reduce their capital commitments. But not every firm is worried about the environment and 23% stated they were in fact looking to increase allocations.

That’s all well and said, but are private equity firms still happy to complete deals? A study from investment house Deutsche Beteiligungs found that one in four private equity houses reported that at least 25% of their portfolio companies were facing liquidity shortages and needed external capital injections. However, while segments of their portfolio might be struggling and in need of more attention only 10% of the surveyed investors intend to limit themselves to maintaining and expanding their existing portfolios, and not a single participant stated that they were too busy with their portfolios to think about new business. This suggests firms will still be looking to deploy their capital and could leave room for them to raise more funds. It’s not just the ability to deploy the capital causing concern but whether GPs will seek to raise funds during this period or if LPs will be cautious in deploying capital.

However, CVC Capital Partners has shown that it can be done. The firm has not only managed to raise an entire fund during the pandemic, it is one of the largest funds of all time, collecting a whopping €21.3bn. The firm reportedly began raising the capital in January 2020 and closed the vehicle in July after attracting a lot of appetite from LPs. This is not the only fund to close during this period. European private equity investor Priveq held the SEK2.5bn ($270m) final close for its sixth flagship fund, having held its first investor meeting in March 2020. UK-based private equity house Tenzing has raced to a £400m final close for its sophomore fund in June, after just nine weeks in the fundraising market.

The new normal

With LPs still happy to contribute to funds, they may be getting used to a new way of business. The Eaton Partners survey claimed that post-pandemic 20% of LPs will be heavily reliant on conference calls as opposed to face-to-face meetings with GPs. Another 53% stated they would use a mixture of virtual and physical meetings and only 27% are looking to revert back to pre-pandemic ways. Due diligence could also change. The survey claims that while 45% of respondents think the coronavirus has had no impact on their processes, 28% stated they are evaluating the procedure.

The pandemic could offer some benefits by highlighting issues with the market and helping to improve the relations between  the LP and GP. Following the financial crisis of 2008, naturally, there was a lack of faith, but since then, regulations and initiatives have been made to ensure something like that doesn’t happen again. A recent study from Coller Capital claims that the trust between limited partners and general partners is only just repairing from the financial crisis. It claims that four in five LPs are satisfied of GPs transparency – a figure which was just two in five post the pandemic. Without the financial crisis, transparency issues may not have been made prevalent and less likely to have been improved.

While the pandemic might put strain on the financial market, it could help to reveal several issues in the market we are currently blind to. It could also help to see measures or contingency plans implemented that ensure more certainty during pandemic times. One potential improvement is a greater sense of realism from private equity firms. A recent study from investment house Deutsche Beteiligungs stated asked 40 private equity firms to rate statements on a scale of 1 to 10. The comment “The coronavirus crisis will not change the private equity business at all” ranked just 3.2, while the statement “the private equity sector will, in general, return to more realism” was rated at 6.2. Other areas changes to private equity from the pandemic is expected to be longer holding periods and an advantage for investors with long-term focus.

Private equity firms and LPs seem to be feeling their way through the pandemic and many are still optimistic about the future. While deal making volume has reached lows not seen since the global financial market, challenges are expected, but firms look like they are prepared.

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