Topic Tags: Private Equity

Second Quarter Review of Asset Allocation: Risks and Opportunities

The second quarter of 2020 proved to be as eventful as the first, with slow economic results being largely ignored as markets rallied. GDP growth for the quarter is expected to come in at -35.5% YoY, though 3Q GDP projections indicate a significant rebound is expected as the country begins to reopen to “the new normal.” In addition, the unemployment rate came in at 11.1%, down from the April peak above 14%. Below are some highlights from the quarter:

  • Countries around the globe began reopening businesses amid fears of a second wave of COVID-19 infections.
  • Daily infections reached a new high in the United States at more than 50,000 per day, causing some states to roll back their reopening plans.
  • Weekly initial claims for unemployment insurance have continued to trend downwards.
  • Additional fiscal and monetary stimulus are expected in the second half of the year, bolstering markets.

COVID-19 has proven to be a potentially long-lasting concern as it remains to be seen whether we are in for a V-shaped or U-shaped recovery. Economic data is improving slowly, though markets have seemed to shrug off some of the negative news as the S&P 500 moved into positive territory over the one-year period. Though it may have fallen into the background due to COVID-19, 2020 is a presidential election year. Uncertainty surrounding the election will undoubtedly have an impact on forward-looking expectations. In this newsletter, we analyze what all of this means for each asset class.

Read > Second Quarter Review of Asset Allocation: Risks and Opportunities

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Best Historical Performing Asset Class Is on Sale!

It is critical for institutional investors to understand the importance of both relative and absolute value when considering investment allocations. From a relative value perspective, private equity ­— which has been one of the most desired and consistently best performing asset classes over the last 20 years — is now on sale.

Following global investment volatility and panic from the COVID-19 crisis in March, the combination of government intervention along with public equity enthusiasm has driven public valuation multiples to near-record levels over the last three months with the Russell 3000 trading at 15x EV/EBITDA (S&P 500 at 23x EV/EBITDA), making the relative value trade even more compelling for private equity investments. Meanwhile, private equity multiples have been more stable, with May transactions occurring at 10x for middle market buyouts and 7.5x for small buyouts less than $100 million in enterprise value, providing investors a 35% or 50% relative discount respectively as compared to the Russell 3000. The current valuation spread provides the widest spread these markets have offered.

Private equity managers have mostly shown investment discipline, thinking longer-term and focused on absolute returns over a multi-year basis, which has resulted in a tighter range of valuations paid as compared to rising public equity multiples over the last decade. However, given the current market dynamics with the valuation spread growing, it is likely private market investors will benefit from the relative outperformance of private equity capital deployed in 2020.

This may be an opportune time for institutional investors to consider stepping back from elevated public market valuations and find ways to allocate more capital and raise their targeted allocations to private equity in order to maximize the absolute returns of their portfolios. We have seen clients increasing their annual deployment and focusing on more opportunistic strategies, including co-investment funds and secondary funds which have shorter investment periods thus allowing more capital to be deployed in 2020 and 2021.

Furthermore, private equity managers should increasingly be thinking about the relative value of the capital that has been committed to them. The last few years have provided for record-breaking fundraising for the private equity industry. This committed capital is currently sitting in dry powder and in most cases remains uncalled from investors sitting in public equity markets. Due to the current valuation spread, the relative value these private equity managers provide by finding opportunities present in the private market is great. Most importantly, more capital being put to work in private markets can expand the number of private equity-owned businesses and does not have to drive up the valuations paid, unlike in public markets where there are a fixed number of opportunities and where more capital being deployed in public equities pushes valuations higher.

Print PDF > Best Historical Performing Asset Class Is on Sale!

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Private Equity in Times of Crisis

While there is still much uncertainty around the long-term economic ramifications of COVID-19, financial markets have been undergoing frequent massive swings as both investment managers and allocators evaluate the situation and what it might mean for their current and future investments. Given the illiquid and slow-moving nature of private equity investments, an outstanding question is: What will this mean for private market investors?

One principle which people took serious note of in the last crisis was something called the “denominator effect.” A decline in the value of one asset should result in other assets being sold to properly rebalance a portfolio, but many assets like venture capital (“VC”), private equity (“PE”), and others can be quite hard to sell in the short-to-medium term, leaving LPs overallocated to private markets. When the stock market falls dramatically, public market investments fall in value immediately; however, private market investments do not reflect the changing environment right away because they require a manual valuation process that is one to two quarters behind public markets.

In addition, LPs allocating to PE and VC can expect net cash flows to turn negative, a break from the norm of recent years when distributions outpaced contributions, which led to positive net cash flows. During a time of crisis, GPs dislike realizing investments at diminished valuations. Instead, they tend to further invest into existing portfolio companies, or at least hold those companies longer, which leads to reduced distributions. Furthermore, GPs also tend to call down capital more slowly during times of market crisis because deal-making slows substantially. It is forecasted that it will take months, possibly even until the end of the year for transaction volumes to rebound.

The exact repercussions the crisis will have on PE fund performance will remain unknown until we know how deeply the virus will affect global economies. However, we do believe private markets will fare well in the current market environment. Research indicates that while PE exhibits high correlation with public market performance over longer periods of time, in times of volatility it tends to drop less and subsequently outperform. Funds deploying cash through the crisis are in a favorable position to deliver elevated returns given the higher likelihood of finding a bargain in a crisis. Previous crisis funds, such as 2001 or 2009 vintages, posted top-tier metrics; the hope is that this pandemic is consistent with these previous patterns for private equity returns.

Print PDF > Private Equity in Times of Crisis

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

What Does the COVID-19 Pandemic Mean for Private Equity Investments?

Given the significant amount of volatility in the public markets and uncertainty surrounding the economic outlook as a result of the COVID-19 pandemic, this newsletter provides an update and outlook for private market investors.

This newsletter covers the valuation process used by private equity and debt funds, the expected impact on first quarter valuations for private market funds, how portfolios are positioned to handle the economic slowdown, what GPs are doing in this environment to protect and position their portfolio companies for the slowdown, and Marquette Associates’ outlook for the remainder of the year.

Read > What Does the COVID-19 Pandemic Mean for Private Equity Investments?

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

 

Q1 2020 Market Insights Video

This video features an in-depth analysis of the first quarter’s performance with a special focus looking forward from the coronavirus pandemic and resulting economic and market impacts.

Our Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real estate, infrastructure, private equity, and private credit, with presentations by our research analysts and directors. For more information, questions, or feedback, please send us an email.

What Have the Last Two Downturns Taught Us About Private Equity?

While each economic downturn is certainly unique, we can look back over the Dot-Com Crisis and the Global Financial Crisis to see how private equity markets performed relative to public equity markets. In both cases, the private equity market1 bottomed 3–6 months later than public markets (due to the lag in reporting), but with a less significant trough. Returns within private equity markets also recovered more quickly as they recovered 1.5–2 years sooner than public markets and generated significant relative outperformance.

The lack of liquidity combined with lagged and overall less frequent reporting works to most investors’ advantages in volatile markets as there is a “smoothing” effect that often generates less fear and the lack of liquidity limits the ability to sell at what may be the worst time for value creation. Quarterly valuations are provided on a 2–3 month lag which provides the benefit of future knowledge on where markets are headed. Perhaps most critical for investors to understand is that throughout an economic downturn — such as the one we are currently experiencing — private equity portfolio allocations will likely rise due to this lag in reporting, but these levels are temporary as markets are correlated to some degree. Unfortunately, some investors look at this temporarily higher allocation (which are predominantly due to the denominator effect) and choose to reduce their private equity program investment; often these liquidations are done at a significant discount. Historically, selling or pulling back on investing has been a big mistake as these investors have missed out on four of the best vintages over the last 25 years.

The primary concern in this downturn is that with a significant portion of the U.S. economy essentially closed, many small businesses do not have sufficient liquidity to weather substantial losses of revenue. However, we would caution that performance will vary by industry and geography as some businesses are operating at relatively high levels in this environment and should be positioned to accelerate as the economy returns to a more normal state. Across the private equity asset class, investor allocations are also higher as reflected by the strong fundraising in recent years, which means the industry is well capitalized to support many businesses throughout this downturn. This significant “dry powder” that private equity firms have at their disposal is likely to be deployed to support existing portfolio companies as well as towards new opportunities that arise from a less competitive landscape as many less well-capitalized businesses will inevitability fail throughout this downturn.

The previous two downturns proved private equity is not immune to public equity market corrections, but the asset class has historically recovered quickly and resumed its place as a return-enhancing component of investor portfolios. Although the denominator effect may drive private equity allocations above intended targets in the context of an overall portfolio, these differences are only temporary in nature and private equity investors are best served to maintain their allocations rather than selling at a steep discount in the secondary market. From a long-term perspective, making consistent allocations and maintaining exposure has best served portfolio returns, and we do not expect that pattern to change in the current downturn.

Print PDF > What Have the Last Two Downturns Taught Us About Private Equity?

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

March 2: Coronavirus Update and Portfolio Guidance

Last week was a painful one for the equity markets as fears about the coronavirus drove investors out of stocks and markets into correction territory. The following newsletter summarizes last week’s developments and provides specific commentary on what to watch for across the major asset classes that constitute investor portfolios.

Read > March 2: Coronavirus Update and Portfolio Guidance

As always, please reach out to your consultant or our research team for more details about any of the information presented in this update. For more Marquette coverage on coronavirus, reference our previous newsletter (January 28) and Chart of the Week posts (February 13, February 21, February 26).

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

2020 Market Preview

2019 was certainly a profitable year for investors as traditional and alternative asset classes delivered positive returns.  As we enter 2020, there are a litany of questions facing global markets ranging from the U.S. election to trade disputes to global monetary policy, all of which will undoubtedly influence investment returns. The following newsletters examine the primary asset classes we cover for our clients, with in-depth analysis of last year’s performance and more importantly, trends, themes, and projections to watch for in 2020.

We hope these materials can assist you and your committees as you plan for the coming year, and please feel free to reach out to any of us should you have further questions about the articles. We have also produced a 2020 Market Preview video if you would like to hear a high-level summary of the market previews. Here’s to another positive year from the markets in 2020!

U.S. Economy: Signs of Slowing?
by Greg Leonberger, FSA, EA, MAAA, Partner, Director of Research

Fixed Income: The New Roaring Twenties — Will It Be Different This Time?
by Ben Mohr, CFA, Director of Fixed Income

U.S. Equities: Climbing the Wall of Worry
by Robert Britenbach, CFA, CIPM Research Analyst, U.S. Equities

Non-U.S. Equities: Big Expectations, Little Wiggle Room
by David Hernandez, CFA, Senior Research Analyst, Non-U.S. Equities
and Nicole Johnson-Barnes, CFA, Research Analyst

Real Estate: What Will Happen Next?
by Jeremy Zirin, CAIA, Senior Research Analyst, Real Assets

Infrastructure: The Energy Revolution Is Driving the Future of Infrastructure
by Jeremy Zirin, CAIA, Senior Research Analyst, Real Assets

Hedge Funds: Rising Geopolitical Risks and a U.S. Election Could Lead to Tempered Expectations
by Joe McGuane, CFA, Senior Research Analyst, Alternatives

Private Equity: As Asset Class Grows, Continues to Deliver for Investors
by Derek Schmidt, CFA, CAIA, Director of Private Equity

Private Credit: An Asset Class Coming Into Its Own
by Brett Graffy, CAIA, Research Analyst

To read the above files in one combined document > 2020 Market Preview

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

2020 Market Preview Video

This video coincides with our annual Market Preview newsletters and includes a recap of 2019’s performance and what investors can expect heading into 2020. 2019 was certainly a profitable year for investors as traditional and alternative asset classes delivered positive returns. As we enter 2020, there are a litany of questions facing global markets ranging from the U.S. election to trade disputes to global monetary policy, all of which will undoubtedly influence investment returns.

This video is part of our Market Insights series, a quarterly presentation designed to brief clients on the market as soon as possible after quarterly market data becomes available. Members of our research team discuss the overall U.S. economy, along with fixed income, U.S. and non-U.S. equity, hedge funds, private equity, real estate, and infrastructure.

For more information, questions, or feedback, please send us an email.

What Does the Next Decade Look Like for Private Equity Investors?

For U.S. private equity investors, it has been a spectacular decade. Through September 2019, EV/ EBITDA¹ multiples, a standard for measuring private equity investment value, stood at 12.8x, just below the 2014 high of 12.9x. This figure marks an 82% increase from 2009, during which the U.S. economy was emerging from the Global Financial Crisis. In addition to revenue growth and EBITDA margin expansion, increasing multiples is a driver of private equity value creation and the most publicized metric on the state of the market.

A decade of increasing multiples has benefited private equity investors and managers. As investors saw the value of their private equity allocations grow, they rewarded managers with increasing amounts of capital. In 2019, global private equity raised $595 billion,² the second-largest sum ever.  A decades’ worth of prolific fundraising, like 2017’s record total of $628 billion, has created substantial amounts of dry powder, or uninvested capital. Today, private equity managers are sitting on $1.43 trillion of dry powder, waiting for investment opportunities to emerge.

These record-setting figures beg investors to ask very important questions regarding the next decade of private equity. Regardless of the past decade, we continue to see a tremendous amount of value in the private equity asset class as a return enhancer and diversifier for portfolios. Undoubtedly, investor scrutiny will increase as the asset class becomes more competitive, and manager differentiation will be paramount.

Print PDF > What Does the Next Decade Look Like for Private Equity Investors?

¹ Enterprise value / earnings before interest, taxes, depreciation, and amortization
² Cummings, C. “Fundraising Stumbled in 2019 From Decade’s Record Pace,”  9 Jan. 2020. The Wall Street Journal.

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.