Welcome to our thoughts on how COVID-19 is affecting private markets investing in the immediate and longer term. We hope you find these of use to you in your forward investment planning.

Overview

• Investors will not see major private markets portfolio valuation hits until the end of Q2. Subject to the specifics of regional markets there's usually an approximate 3-month lag in private markets pricing following shock events.
• Many equity strategies across Private Equity, Real Estate and Infrastructure could then face material write downs. We anticipate rising tensions in GP/LP relationships with a small number of LP defaults already reported in Europe.
• Most lenders / credit investors are being or will be impacted by public bond market pricing, which has increased significantly thus far. Senior lending and yielding asset-backed strategies can expect to be best protected; existing more junior lending and equity tranches are more vulnerable.
• Older vintage funds and portfolios are at most risk. In line with previous crises (1987, 1990/91, 1999/2000 dotcom bubble and the 2008/09 GFC), the more recent fundraises and current vintages (and those raised in the next 12-24months) might expect to see some excellent returns for investors, particularly from top tier managers.
• The roles of governments and central banks will be key, more so than in previous crises (including even 2008/09 GFC). Whether through the pumping of liquidity into the system, regulations forgiving debtors, protections for tenants or workers, or just plain taxpayer-funded bailouts, losses are being socialised to such unparalleled and unsustainable levels that they call into question capitalism’s very foundations. While such actions may mitigate, to some extent, outcomes in the short term, they raise new or exacerbate existing risks materially and, therefore, increase the possibility of much larger calamities for all investors down the line, possibly sooner rather than later.

Private Equity and Real Estate

Although we don't especially feature in this initial series Private Equity and Real Estate strategies (as we've hitherto viewed these as riskier in the short term, mainly due to pricing, leverage and quality concerns - and have to date therefore steered clear of equity managers in such strategies), we do have the following observations:

Private Equity

Given the GP experience of 2008-10, we're already seeing early calls from managers to draw down LP commitments for three principal reasons:

• Underlying existing investments are more likely to need earlier or more support;
• An expectation of a vastly improving set of deployment opportunities, by both volume and pricing;
• "Normal" crisis cash paranoia.

Investors should anticipate an additional 12-18months or more deferral on previously expected distributions.

Reports of LP defaults are so far minimal, though we expect these to grow.

LPs might be best advised to exercise caution in approving GP requests for adjustments to current terms (fund duration extensions, mandate changes eg to include flexibility to investing in debt or follow-on capital/recycled proceeds into existing companies). Liquidity should and usually does follow success, not failure.

Looking further out, the opportunities and specialist strategies many investors will seek to overweight include healthcare (infrastructure and life sciences), non-discretionary consumer staples and technology (but not all sub-sectors). We also anticipate increased opportunities over the next 2-3 years in secondaries, distressed and special situations.

Real Estate

Many open-ended funds have, sensibly and (in the UK) in line with FCA rules, suspended trading and we also know of some funds that have closed. Most private markets Real Estate GPs are under less pressure for the timebeing at least. But the risk of LPs defaulting on their capital commitments is, undoubtedly, rising.

Tenant and landlord relationships can be expected to come under intense pressure over the next 12 months and, perhaps, for a number of years. We expect a wave of substantial tenant defaults in the 2nd Quarter (up to 80% perhaps in some sectors, especially retail, office and PRS perhaps). There are some mitigants - government support packages for tenants, lower interest/loan rates, etc. - but these will hit value and valuations hard.

As for construction assets, beyond the new uncertainties of supply-chain resilience affecting all sectors - especially the issues surrounding social distancing, workers and materials (particularly if imported), transportation, and so on - we see specific issues ahead for new office construction, and a repositioning following the increased propensity for home-working.

It's not all doom and gloom for city office demand however, as complex factors are at play; for example, whilst overall office worker demand may decline, the desk space needed to accommodate each worker in a social distancing "safety" environment could rise, and thus compensate to some degree....(and to the extent any of this is "permanent")! In that complexity, in time, there may even be some hope for flexible office providers; a sector that's set to take somewhat of a beating short term.

The comments above on older vintages seem to apply to an even greater extent for Private Equity and Real Estate sectors.