Despite the profound economic shock that continues to play out, global investors in private assets appear to be quietly confident that this is a major but temporary setback. Two players in Luxembourg’s financial sector share this cautious optimism as they see investors taking a long-term view.
‘I think it is very likely that we will see the number of deals rising in the coming months because valuations are likely to be more in line with the fundamentals,’ said Ludovic Fichet (pictured), Head of Non-Financial Assets Portfolio Management at the asset manager BIL Manage Invest. ‘Though we will need to wait until the end of the year before we can accurately gauge the full impact of the virus.’
A similar picture was painted by Brian McMahon, Global Head of Credit & Debt fund services at the fund services provider BNY Mellon. ‘By and large the industry is robust, strong and growing and there is confidence,’ he said, before adding ‘funds will need to keep a close eye on valuations and there will be a lot more work to do in this area.’
Cautious optimism
Indeed this outlook appears to be reflected in the share prices of leading private equity firms being only 5-10% below their positions at the start of the year. Optimists point to pent-up investment being ready to ride to the rescue of fundamentally sound businesses struggling with short-term liquidity problems. The global private equity industry is estimated to have $1.6trn of dry powder ready to deploy, according to the analysts Preqin.
Optimism isn’t universal though. ‘Fidelity chief warns of global corporate solvency crisis’ was a Financial Times headline on 7 June. The European Central Bank’s May Financial Stability Review pointed to ‘declines in expected income from investments and premiums are likely to weigh on profitability and solvency. A recent Deutsche Bank survey estimated that nearly one-fifth of US firms now have debt servicing costs greater than their profits – a figure which has more than doubled in the last ten years.
cMahon thinks this concern shouldn’t be exaggerated. ‘We still have to see how the market recovers, but in general investors have long-term horizons. Looking across the fund ranges we administer in the EMEA region, across all asset classes, we have one fund that has deferred some redemptions,’ he said. Nevertheless, he says, the industry is aware of the potential challenges and is keeping watch. Fichet broadly agrees: ‘We have seen a lot of regulation in recent years that was beneficial, with investors having enough information – sometimes too much information – to understand the risks they are taking. Only sophisticated individual investors and institutions expose themselves to alternative asset classes, and they know there is the risk of losing everything as well as making strong returns.’
Early days
So while short-term concerns may be limited, there are still doubts around how the economy will perform as fiscal support provided by global governments is withdrawn. ‘It’s still very early for all alternative asset classes, be they private equity, debt or real estate, and I don’t have a crystal ball,’ said Fichet. Hence why most advisors recommend holding these investments for around 10 years or more. Indeed Fichet thinks investors are ill-served by asset managers which seeking to create liquid funds from highly illiquid assets. ‘Value is created by the fund manager working with companies and partners. But if you spend all your time calculating net asset values you are losing a part of your competitive advantage as a fund manager,’ he said.
Especially private equity and debt has been a booming industry of late given the potential high returns on offer. Last year Alfi pointed to a 50% increase in private equity assets under management in Luxembourg in 2019, and a 40% rise in private debt fund assets over two years. Funds invested in private equity during the 2007-2009 crisis have yielded an annualised return of 18%, say Preqin.
This success had caused bottlenecks. ‘In private equity there had been many deals but with very high valuations, so that in recent months it had become difficult to deploy capital,’ said Fichet. This crisis might allow this process to be conducted in a more sustainable fashion. Funds also have the advantage of being relatively nimble compared to banks when it comes to offering cash flow to fundamentally strong projects. They also have a high degree of flexibility if they need to restructure their portfolios to account for poor performances of some assets. As well, governments and central banks continue to signal their willingness to do what it takes to help the global economy through the slump.
‘When I look at how our clients are pursuing their business there is still some very bullish behaviour with clients launching large funds,’ said McMahon. The picture should become clearer as second quarter valuations are published.