Analysis: The Flood Gates Swing Open

With so much private equity activity put on hold by Covid-19, 2021 could set fundraising and secondary records.

By Q2 of this year, PE net asset values were just a hair’s breadth from pre-crisis levels. By the end of Q3, both net asset values and prices for PE funds sold on the secondary market were above pre-crisis marks (see first graph on p. 1). The overall economic recovery from Covid-19 may well prove grinding and slow, but so far the rebound for private equity is V-shaped. The 9-months it’s taken for two of the most important indicators of private equity’s health to soar past pre-Covid 19 highs compares to a 24-month recovery from the lows of the global financial crisis (more on the GFC in our June Market Analysis).

PE fundraising has held up remarkably well with $720 billion raised for a broad range of PE strategies in 2020, according to our preliminary estimates (see second graph on p. 1). That’s some 10 percent below last year’s level and just 5 percent below the average for the previous five years, a period of fundraising success without equal. A disproportionate percentage of commitments went to large, brand-name groups, representing a flight to the familiar at a time when due diligencing managers has been sharply curtailed by travel restrictions.

But the exceptional capacity of smaller, usually more specialized managers to respond rapidly to the pandemic’s challenges and to take advantage of short windows of buying opportunity, has been recognized by investors (see our roundtable on p. 3). The relative dearth of commitments to smaller managers and the growing divide between the record purchase price multiples for large-cap firms – highly influenced by sky-high values for publicly-quoted comparables – and relative bargains among more cash-strapped mid- and small-cap firms is heralding a significant fundraising swing – already noticeable in this year’s fourth quarter – to smaller, more specialized managers in 2021.

In PE, the economic uncertainties tied to Covid-19 have arguably taken their largest toll in the pace of realized investments. As PE groups stepped back from portfolio company sales processes, evaluated the vulnerabilities of their portfolio companies and shored up their finances, the number of exits dropped sharply. At the same time, purchases continued apace, particularly as larger companies sold off divisions, and mid-sized and smaller companies welcomed transactions as a means to bulk up both equity and debt financing in the face

of the crisis. The result: capital distributions to PE investors from portfolio company sales this year fell below capital calls to finance new investments for the first time since 2011 (see third graph on p. 1), leaving many PE programs cash negative.

With many investors eager to increase allocations to PE and economic challenges in many sectors and regions likely to open up exceptionally attractive buying opportunities, the distribution/call mismatch could leave some short of capital just when they want to overweight private equity. Net-cash negative positions for many programs should, however, provide impetus for portfolio cleanups using the secondary market.

With PE fund net asset values rising to 106 percent of the pre-crisis mark after a relatively modest 8 percent write down in Q1, and certainties growing regarding sustained monetary and fiscal support for economies and effective vaccines, volume in the secondary market

soared to $50 billion in H2, following an H1 total of $21 billion. But in 2020, for the first time a majority (52 percent) of annual secondary market volume was accounted for by GP-led deals. They put large sums to work in one go in a market with few LP-stake offerings. Total volume of $71 billion in 2020 trails last year’s record of $83 billion, when 36 percent of deals were GP-led.

Attractive pricing for sellers in a number of categories, in particular large leveraged buyout funds – currently at 96 percent of net asset value, just shy of the 98 percent five-year annual average – (see graph 4 on p. 1) should lead to a resurgence in LP-stake sales in 2021,

very possibly a new volume record for secondaries, and fresh cash for primary commitments, which may also rise to record levels. Even heavily out of favor sectors – notably energy, where Triago has seen no secondary sales in H2 2020 – are likely to get a relative boost over the coming year as specialists and the secondary pockets of funds-of-funds seek to deploy $153 billion in unspent capital earmarked for secondaries.