Private equity as an asset class has grown substantially since the global financial crisis, and firms have broader strategies and tools available to them than ever before.
Just over a decade on, the industry faces another significant challenge. In the first of a two-part series, S&P Global Market Intelligence looks at how the institutionalization of the asset class, record levels of dry powder and a more flexible approach to fund management will affect how the private equity industry is impacted by the coronavirus outbreak.
Private equity has matured
As private equity has matured it has, to a certain extent, become institutionalized, Dechert LLP private equity Partner Chris Field said. "There may be debate around what impact [the coronavirus outbreak] has on returns, but in terms of surviving what we're all hopeful is a short but significant shock, I think that will give a lot of positives."
The asset class has also become more sophisticated, Thiha Tun, Dechert private investment funds and transactions partner, said. Many managers have weathered tough periods since the global financial crisis, or GFC, including the oil price collapse of 2014 and wider geopolitical issues such as sanctions in the Middle East. "As a result of that, private equity has really focused on value generation as well as value preservation. And that is, I think, one of the big differences with the situation today compared to 2008," Tun said.
Record amounts of dry powder
Limited partners have piled into private equity investments over the past decade as they seek premium returns to those of public markets. Private equity assets under management have more than doubled since the GFC, with firms now managing $3.8 trillion, according to Ernst & Young LLP's March report "Why private equity can endure the next economic downturn." Dry powder exclusively allocated to the asset class reached $1.4 trillion as of December 2019, a record high and almost double the 2015 level of $750 billion, according to Preqin Ltd.
The availability of cash, whether it was in the banking system or elsewhere, was a key consideration during the GFC. "That motto cash is king was absolutely critical back in 2008," Tun said. The outlook couldn't be more different for private equity today. "How do you invest into an economy where nobody is doing a lot, because we're all sitting at home? So that, I think, is the challenge," Field said, adding that the industry's adoption of additional strategies will be a significant benefit.
The record amount of dry powder has "big advantages," but it is impossible to know how much will be available to firms down the line, especially if the coronavirus crisis worsens and LPs do not honor all of their commitments, Eamon Devlin, MJ Hudson Group PLC corporate and investment funds partner, said.
Median internal rate of returns for global buyout funds show a relatively low performance prior to the dot-com crash in 2000 and the GFC in 2007, but performance was stronger during both recoveries as the asset class began deploying cash in a low valuation environment, according to EY's report. "Recognition of this pattern is keeping firms disciplined in today’s market and has many looking at the next downturn as a time to be ready to react accordingly and capitalize on the potential significant opportunity," the report said.
Fund life reviewed
Dechert's Tun said that before 2008, funds across the board typically had seven- to nine-year life spans. "It didn't really matter what sort of fund you were doing, whether it was private equity or real estate or infrastructure, they all almost had similar life spans." Post-GFC, the industry recalibrated the life of a fund to make vehicles more suitable for the underlying asset class.
Private equity's secondary market has also matured and evolved to a point where general partner-led restructurings, once seen as an embarrassing sign for both GPs as well as LPs delivering the news to their investment committees, are now seen as attractive options to extend fund life and offer liquidity to investors.
Likewise, Dechert has seen a number of transfers of assets between a fund coming to the end of its life and a new one that has been launched, Tun said. As long as managers are doing this for value preservation or enhancement, rather than in order to continue earning management fees on the investment, and have conveyed this to LPs, investors are "pretty relaxed about it," he added.