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Covid-19 – Short Term Pain, Long Term Gain

Lessons learned with COVID-19 are numerous. Slowdowns in market transactions, deal flows, capital calls and exits show the impact of this unprecedented black swan. While Private equity valuation has grown for ten years, in the last week’s global equity dropped by 50% and hedge funds by 30%. Fundraising had been stopped as Limited Partners (LPs) don’t want to buy equity at the previous value. There will be a re-pricing. On the one hand, the energy industry is already trying to recover the supply storm many sectors such as retail, airlines, and tourism are negatively impacted. On the other hand, other industries such as healthcare, technology and telecom benefit from the situation.

In the meantime, General Partners (GPs) are keeping up to date their investors and multiplying their communication about the COVID-19 impacts but some fund managers reveal during the “Alternatives in 2020” event organized by Preqin that LPs are still demanding for accurate fund performances and NAV calculation. Investors impose restrictions and higher transparency, portfolio reporting, valuation analysis, market valuations, secondary market and exit options along with operational due diligence continuity planning.

In this context, a risk of overreporting has been created by GPs that failed to create the expected strengthening of their relationships with LPs. Market data is creating a loss of clarity while GPs are trying to attract the LPs interest and the high level of dry powder available. GPs are challenged by their ability to fundraise investors, to create deal origination and the restrictions in portfolio company operations. In front of that, LPs are pushed to naturally adopt an overall sell position, which is widening the gaps between the distributions and capital calls. Discount value re-modelizations on equity at 2-3 years are expected and fundraising operation temporarily froze.

To date, twelve thousand financial institutions and investors are actively investing in alternatives including private equity, real estate, infrastructure, private debt, and natural resources. Diversification remains the key reason for private equity investments that serve a median net IRR of 14,9%. Private equity investments continue to show a superiority model through corporate governance and reactivity plus the ability of the industry to take harsh restriction decisions away from public markets. Quality of GP communication on fund performances and portfolio strip by strip remain the challenges to managing in the LPs relationship along with the fee structure and accurate cash flow forecasts to steer allocation.

In two words, short-terminism is not the right answer to the crisis generated by the COVID-19 pandemic while well-managed alternatives remain the best way to overperform on markets. After the quarantine, there will be a slowdown in transactions and fundraisings. Actually, funds don’t want to buy assets of their previous value. Re-pricing is in the air and so many opportunities are coming in. It is time to play in favor of the secondary asset class that is the sheer level of diversification. But they are several unknowns regarding the use of leverage, working capital facilities, and secondary buyers. On the other hand, the GP lead transactions will be needed a higher number of buyers willing to acquire portfolios of highly concentrated assets.