The private equity market was on a hot streak coming into 2020 and despite the economic wreckage caused by the coronavirus, fundraising has generally held up, said Jamie Becker, counsel for private equity and pension fund investments at Torys LLP, when speaking at the Canadian Investment Review’s 2020 Global Investment Conference in September.
“There was concern at the beginning of the pandemic that [general partners] would turn inward and focus on their own portfolio and [limited partners] would also stop their fund investment activities. Travel restrictions meant that GPs couldn’t go and market to LPs and LPs couldn’t go do onsite due diligence or meet the investment team,” said Becker. “Luckily, that hasn’t actually played out and the first half of 2020 actually raised more capital than the first half of 2019, albeit in fewer funds.”
The fundraising has been driven largely by established managers, whereas smaller, emerging managers are finding it more difficult to raise capital in the current environment.
Generally, the concept of the denominator effect exists with private equity, Becker noted. “The denominator effect suggests that an institutional investor’s private equity allocation is fixed as a percentage of its overall portfolio. As the portfolio decreases in value, the absolute value of the private equity allocation goes down along with it.”
But the coronavirus hasn’t led to investors adjusting their private equity allocations. Some reasons for this include the crisis being temporary in nature, so LPs aren’t adjusting their portfolios and public markets have more or less bounced back to where they were before the coronavirus, Becker said. Further, institutional investors have learned lessons from the global financial crisis. “In the [global] financial crisis, funds that were launched tended to outperform funds that were launched before or after. Managers were investing at the bottom of the market, so there’s a lot of opportunities, and those funds performed very well. We’ve heard from our institutional investor clients that they don’t want to make that same mistake again and pause their fund commitments like they did in the [global] financial crisis and miss out on this great vintage of funds.”
Co-investments were very popular going into the coronavirus crisis, but the pandemic has made merger and acquisition opportunities scarce, so fewer co-investments will likely occur going forward, Becker said. “LPs that we represent who had a steady stream of co-investment opportunities before the pandemic have seen that completely dry up, although we’re seeing a bit of an uptick now.”
For the few opportunities that do exist, many LPs will be trying to get access and the GPs will be able to dictate the terms, Becker added.
And when it comes to the secondary market, fundraising has been strong since the first half of 2020. “It’s actually stronger than the rest of the fundraising market. The two biggest funds that closed in the first half of 2020 were actually secondaries funds. Given the strong fundraising and the existing dry powder in these funds and the shorter investment periods that secondaries funds tend to have to deploy capital, we expect that the secondary market will continue on its upward trajectory.”
LPs facing liquidity needs may be looking to sell more of their interests into the secondary market, Becker said, noting GPs are also going to access the market for liquidity.
GPs can also get liquidity through preferred equity financing. “This is another secondary market tool that was popular pre-pandemic. Given heightened needs for capital these days with portfolio companies, we expect to see more preferred equity financing as things go forward into late 2020 and early 2021.”