Public markets have rapidly responded to the current and potential impact of the pandemic crisis, displaying extreme volatility, particularly in the case of equities. But how are private markets responding to the impact of the crisis?
Within private markets we invest in private equity, infrastructure, real estate, natural resources and private debt. Each asset class is more or less exposed to growth, interest rates and inflation expectations of the global economy.
We are considering this crisis and its impacts in three stages: lockdown – where the world attempts to contain the virus; recovery – where we seek treatment and a vaccine while learning to live with the virus; and in the long run, seeking to identify the ‘new normal’.
We are focusing on liquidity during the lockdown period, how to navigate the coming recovery as we exit lockdown, and how to position investments to suit the future new economic environment as it becomes clearer.
Impact of lockdown on private markets
The pandemic is accelerating trends that were already in place pre-crisis.
The pandemic is accelerating trends that were already in place pre-crisis. The trend towards online retail has been magnified as consumers are forced to shop online. Within real estate, retailers are struggling to pay their rent; conversely, logistics assets are much sought after. There has been an acceleration of online service usage in venture capital and growth stage private equity, where portfolio companies have benefited from the need to dramatically reduce human contact.
Real estate valuations are currently uncertain, and agents are unable to provide valuations upon which net asset values can be struck. There are few transactions occurring, and investors cannot travel to perform due diligence on potential investments. Hence, there is limited liquidity within the market.
Income collection has fallen as the economic impact reduces revenues of tenants, meaning rents have been deferred in some cases. The leisure sector, including hotels and restaurants, has been severely affected by high operating costs. Meanwhile, occupancy and customer footfall remains low.
There has been less impact on concession infrastructure. This usually remains in operation irrespective of the economic climate, and is underpinned by government contracts. These are defensive investments. From an economic infrastructure perspective, any asset that relies on through-traffic or volumes to generate income may be affected by lockdown.
Impact on performance
Some private market asset classes use leverage. This can leave them more vulnerable than other investments in times of financial and economic crisis. Credit markets have been stressed, and little new lending is being originated. Policymakers are seeking to avert a credit crisis, and this has relieved some of the pressure.
There is no real-time pricing available due to the private nature of the investments. Private market investment returns are typically less volatile than public markets as a result of infrequent pricing. However, valuations are contingent on what could be achieved in an orderly sales environment. As a result, private markets tend to lag public markets in timing.
What will happen to dry powder (cash awaiting investment)?
Over the last few years, the amount of investor capital committed to private market investments that is yet to be invested has grown dramatically. There is circa $2.6 trillion of cash in private markets. There is some concern among investors that capital will be called to invest at an unsustainable rate, as private market investment opportunities present themselves at the same time as the value of asset allocators' public market investments has decreased substantially.
Deal making tends to be depressed during periods of recession. There is likely to be a dearth of investment opportunities over coming months as potential sellers avoid selling assets wherever possible, projects are delayed and developments put on hold. Purchasers will be cautious about buying until there is some clarity around the trading and finances of targets.
Planning for the new economic environment
The secular trends of capital formation occurring outside of publicly traded markets, and of companies staying private for longer, are likely to be reinforced by the current crisis. The concept of private equity began in the 1980s, while stock markets have been in operation for hundreds of years. With the advent of the internet it became a lot less capital intensive to start and operate a business.
In the case of venture capital and growth stage private equity, while the exit route has changed for these privately held companies, the institutional demand to access high growth investment opportunities remains. In fact, crises can be the mother of invention. For example, companies founded in 2008/09 have gone on to become extremely successful.
Where an initial public offering was once a favoured exit route, large corporations and listed asset managers now provide exit opportunities. Often, these private companies are technology or healthcare focused. These companies should continue to be attractive future investments.
How will fiscal policy evolve? To what extent will the relationship between governments and the private sector change?
The role of private capital in infrastructure spending should grow as the required capital investment around the world remains high. At the same time, policymakers may be more inclined to pursue long-term fiscal spending plans to boost productivity.
Investments in timber and agriculture can offer investors a long-term inflation hedge. This type of investment could play an important future role if fiscal policy goes on to become a dominant force.
As private markets have developed there has been increasing regulation and oversight. At the same time, the clarity of approaches to addressing environmental, social and governance (ESG) issues has improved. Because the investor base has changed over time, and is predominantly institutional, there may be calls for greater transparency, similar to that which we see in the more heavily regulated financial services areas.
The requirement for diversification and return generation in the face of very low interest rates and extreme volatility in listed equities is probably reinforced by recent events. As financial markets and returns within them are hollowed out by the current crisis, clients are likely to need to create diversification within their portfolios, and take on private markets exposure. They will need to demand a suitable premium for locking their money up, however. The current cyclical downturn is likely to create compelling opportunities within private markets. The secular trends that have been highlighted above also remain in place, and we expect private markets to continue to grow as a share of total investable assets.