We entered 2020 with strong fundamentals across the whole spectrum of private markets, from corporate health in terms of private credit and equity to real assets investments like infrastructure or real estate. Private markets are a much larger part of the investment universe, having tripled in size from US$2.5 trillion at the end of 2007 to just under US$8 trillion today. There’s also more variety and a much larger role for private markets in many portfolios today.
Since the onset of the pandemic, we have experienced a live stress test of the financial and investment-structure resilience of alternative investments, which include assets like private equity, infrastructure, real estate credit and hedge funds. Remember, these are long-term investments, so anticipating downturns and building in that resilience is part of the investment process. This was reflected in Q1 valuations, including in private equity, which saw a 10% to 15% drop with some variance between industries, and in real estate and private credit, where we have seen low- to mid-single-digit drops.
We are also seeing investment activity continuing, particularly in diversified assets, assets with strong underlying fundamentals or assets that play to powerful long-term trends, like the global energy transition that’s creating significant opportunities for investments in renewable power.
As such, there’s been some bifurcation between harder hit assets, such as travel, real estate and transportation, and assets where fundamentals have been strong, such as technology, part of healthcare and distribution centres.
Many corporates are also looking to bridge the uncertainty to better economic conditions. Even less severely affected companies are looking to add liquidity. A case in point, we’ve been approached by larger companies who might not normally look to the private channel for liquidity because they need fast, flexible capital. Building higher quality into portfolios is a dominant theme today.
What notable investment themes are you seeing emerge amid ongoing uncertainty?
I’ll point to three.
First, the size of the policy response so far and the expectations for future actions, if needed, have underpinned the financial markets. However, the level of uncertainty from other factors is higher today than before the coronavirus crisis, including the potential for a second wave, geopolitical tensions, and the uncertainty around US presidential elections in November. This indicates that long term underwriting needs to remain robust.
Second, the changes to the economy are likely to be much greater than those we saw post-global financial crisis. We can already see this crisis accelerating some trends, such as the decline of bricks-and-mortar retail, while reversing others, like the reliance on optimized global supply chains. When you’re making long-term, illiquid investments in companies and real assets you have to think hard about how these trends and risks are going to play out. It will be important to price the asset relative to the risks that the underlying cashflows will face rather than relative to pre-Covid-19 levels. Patience and discipline will be key, but we will also be competitive where we see opportunities that others may not.
My third point is about sustainability. Some argue that sustainability is a luxury we can’t afford in a downturn, but we think the opposite. If Covid-19 shows us anything, it’s how quickly a non-financial risk becomes a financial risk. For us, environmental, social and governance (ESG) investing means thinking about risk in the most comprehensive way possible. Especially for climate change and its impact on policy and markets, this only becomes more important when investments are long-term and illiquid.
How are sourcing and deal flow evolving?
We saw the slowdown you’d expect in the early days of the crisis, when uncertainty was at its greatest, but deal flow has been resilient since. Our global sourcing pipeline for the first four months of the year included over a thousand opportunities, which was down about 12% from Q4 2019. Geographically, we’re seeing Asia-Pacific increase as a percentage of total flow, reflecting their earlier emergence from lockdown. But the US is still dominant, with 57% of active deals. By sector, we’re seeing the greatest increases in transportation, healthcare and technology and the biggest decrease in energy. We expect deal flow to increase in the second half, with financial stress providing negative catalysts and greater clarity on growth opportunities providing positive catalysts.
Where do you see the greatest investment opportunities in the current environment?
We believe that the greater size of the market and the greater variety of investment types compared to the 2008 financial crisis period means that private capital will play a more prominent role in the economic recovery to come. And because it is fast, flexible capital that companies can source quickly, it can finance things that public markets aren’t suited for. We are seeing and expect to see investible opportunities across private equity, credit, real assets, and hedge funds.
I will give you three main types of deals:
Liquidity bridges – Capital infusions for high quality companies that have lost bank financing or otherwise need a “bridge” to better times given cashflow timing issues. These could include sale leaseback structures against equipment or real estate to generate near-term liquidity given a depressed top-line outlook.
Forced sales – Sellers will want to divest assets, and speed, trust and privacy will be key. Therefore, we anticipate that quality assets will become available at attractive pricing. We see this happening whether we experience a prolonged downturn or a period of accelerated changes brought about by the crisis. Private equity secondaries are one of the most interesting opportunities here. General Partner-led deals currently predominate. We’re seeing GPs offering preferred equity investment into portfolios of companies where they want to direct capital to the individual businesses for either defensive or offensive reasons. As the year goes on, we expect to see more limited partner (LP)-led deals, where an LP wishes to sell its interest in a private equity fund. The “denominator effect”, where investors need to rebalance their portfolios after a decline in public market valuations, will drive some of these.
The acceleration of structural trends – They are creating new opportunities for private markets investment:
* An example of this is telemedicine. An April survey by the Physicians Foundation in the US found 48% of physicians using telemedicine, up from 18% two years earlier, and consultancy Oliver Wyman reports 10 to 20-fold increases in telemedicine usage in some provider systems. The pandemic has accelerated the adoption of telemedicine both from a consumer perspective and from a regulatory perspective, including the temporary policy change that made telemedicine reimbursable by Medicare in the US. These opportunities are arising in private credit and in private equity.
* The transition to a lower-carbon economy is another example. Investments in wind and solar generation assets have proven resilient through the downturn and they have the advantage of being part of a long-term structural shift to greener-generation capacity, based on attractive economics as well as changing societal attitudes. The International Energy Agency’s base case scenario is that the world will transition from generating about two-thirds of its energy from fossil fuels today, to generating two-thirds from renewable sources in 2050. And we don’t see anything interrupting that deep structural trend.
Jim Barry is chief investment officer of BlackRock Alternative Investors