Navigating the COVID crisis with skill and dexterity
Investors looking for attractive risk-adjusted returns over the long term might consider private equity, which has strong credentials and can offer significant diversification benefits when added to a wider portfolio of assets.
While there can be significant barriers to entry for those seeking to tap into the opportunities presented by private equity, one accessible way is to buy shares in a private equity investment trust, which is a closed-ended investment company that is listed on a stock exchange. Here, Helen Steers, manager of one such investment trust Pantheon International Plc (PIP), discusses how the private equity market has responded so far to the Covid-19 pandemic, and considers the outlook for the asset class into 2022.
There is no doubt that the turbulence caused by the Covid-19 health crisis has reverberated through every region of the world, resulting in vast social and economic damage and generating extraordinary movements in financial markets. At the time of writing, many countries are beginning to emerge slowly from the pandemic, supported by the unprecedented policy actions of their governments, and the accelerating rollout of vaccination programmes.
The major economies are showing initial signs of a sustained rebound, driven by increased consumer and business confidence. Of course, this cautiously positive outlook may be threatened by the emergence of new variants of the Covid-19 virus, a potential slowdown in consumer spending and the withdrawal of government support. In addition, inflation concerns are taking hold and the public markets are already pricing a potential rise into their assumptions, although it is unclear whether inflationary pressures may be transitory or longer lasting.
The indications are that private equity has been left relatively unscathed by the Covid-19 crisis, with deal activity, exits and fundraising all recovering strongly in the second half of 2020, and into 2021.
Furthermore, private equity performance through the crisis has been robust, and the asset class has demonstrated lower volatility than public markets. Although private equity valuations dipped in the first half of 2020, as a result of the onset of the Covid-19 crisis, they did not fall as far as the public markets and rebounded strongly in the second half of the year. After a hiatus in deal and exit activity during the second quarter of 2020, private equity bounced back to end the year only slightly behind 2019. Fundraising activity was also strong overall, although there was a bifurcation between the most in-demand, invitation-only funds, which closed rapidly and at their caps, versus less popular vehicles.
There is now an estimated USD1.6 trillion of dry powder (capital raised and available to invest but not yet deployed) globally.
In line with the private equity sector overall, deal volumes in the global private equity secondaries market, which were lower in 2020 (USD60 billion) compared to 2019 (USD88 billion), rebounded strongly in the second half of 2020, and continued to expand in the first half of 2021; (secondaries provide liquidity to private equity investors allowing them to sell positions in already established private equity funds). Against a backdrop of more certainty around the economic recovery, we expect volumes in the secondaries market to return to pre-Covid-19 levels in 2021.
The number of single-asset secondaries, which form part of the manager-led activity, has been rising and growing at a faster rate than any other segment of the manager-led space. Single-asset deals occur when the private equity manager has carved an individual company out of an older fund that is coming to the end of its life and moved it into a continuation vehicle. These deals allow the existing investors in the fund to exit their positions while offering an opportunity for other investors to invest in the continued success of the portfolio company. This a very specialised area of the secondaries market and an increasing part of PIP’s portfolio.
Co-investments, typically free of management and performance fees, enable PIP to invest directly in portfolio companies at the same time, and on the same terms and conditions as the private equity manager. We are an attractive co-investor for our GPs because we are known to be reliable, responsive and have the scale to deploy capital quickly and efficiently, and also have the flexibility to co-underwrite transactions. We have seen co-investment deal flow return to pre-Covid-19 levels and co-investments form a significant and attractive part of PIP’s deal pipeline.
PIP’s portfolio is tilted towards the Information Technology, Healthcare and Consumer Staples and Services sectors, which have been resilient throughout the pandemic, with certain sub-segments such as enterprise application software, education services, internet retail and interactive home entertainment benefitting from existing social and business trends that have been significantly accelerated. We remain alert, however, to the relatively high valuations in the market particularly in Information Technology and Healthcare, and are focused on targeting the most promising sub-segments within these broad sectors.
This crisis has highlighted the fact that technology is an enabler across many other industry sectors as well as being a vertical sector in its own right. Digital transformation is one of several tools that many of our private equity managers use to enhance products and improve efficiencies both within their own businesses and those of their portfolio companies. In recognition of its growing importance, many managers have experts on staff.
The USD5.3 trillion global private equity market has more than doubled in size over the last 10 years and is expected to continue to benefit from the increase in supply of private company investment opportunities, and the demand for private capital. Private equity managers often invest in family-owned or founder-led firms where they can help with formalising organisational structures in addition to helping them grow internationally or into new markets.
Institutional investors have been increasing their allocations to private equity as they target higher returns, a more diverse set of opportunities and the ability to tap into the growth phase of a company’s development before it goes public, if indeed it does IPO at all. Through Pantheon’s platform, investors in PIP can access carefully selected high-growth, exciting privately-owned companies around the world. The hands-on approach of our private equity managers has consistently resulted in significantly stronger revenue and earnings growth in the underlying companies in PIP’s portfolio when compared to those of the MSCI World index.
In the short to medium term, it is expected that global economic growth will be propelled by the return of business confidence and the strength of consumer spending across the developed world as households wind down excess savings that have been built up over the last 12-18 months. However, we have all lived through the unpredictability of the pandemic over the past 18 months, and there still remains the threat of new waves and strains of the Covid-19 virus.
While private equity is not immune to these events, which are affecting us all, we believe that its inherent ability to be nimble, flexible and respond quickly to changing market dynamics means that private equity, and PIP with its more than 33-year track record, has the ability to emerge strongly from the Covid-19 crisis.