One in 10 companies owned by private equity managers is in “intensive care” as a result of the coronavirus pandemic, sparking concerns that alternative funds could suffer performance hits and reputational damage.
Private equity managers reported that half of the companies they owned were moderately or very affected by the economic disruption caused by the global health crisis, according to an analysis by three finance professors.
The academics collected data from 214 private equity managers overseeing combined assets of $1.9tn during July and August to assess how they were responding to the pandemic.
“As a result of the pandemic, the PE [managers] expect the performance of their existing funds to decline,” the professors said.
High-fee private equity funds have performed no better on average than an inexpensive US stock market tracker since 2006, but a handful of the industry’s top barons have accumulated multibillion-dollar fortunes, leading to debate over whether investors are receiving a fair deal.
The academic research found that almost nine out of 10 managers said fund performance, measured by the internal rate of return (IRR), would be reduced by problems among their portfolio companies.
The gross IRR (excluding fees) is expected to be 4.4 percentage points lower on average at 22.6 per cent in 2020, compared with a similar survey conducted in 2013.
The gross multiple of invested capital, another key performance metric, is expected to drop to 2.69 in 2020 from 2.85 in the previous 2013 survey.
“This will make outperformance of public markets, particularly the S&P 500, more difficult going forward [for PE funds],” said Paul Gompers, one of the authors and a professor at Harvard Business School.
The S&P 500 rose 3.2 per cent in the first nine months of 2020 and touched an all-time high in early September.
Mr Gompers said that increases in deal prices and declines in long-term interest rates had also contributed to the reduction in expected returns for private equity strategies.
Accessing additional sources of liquidity has been a priority for the 10 per cent of portfolio companies classified as in need of intensive care. More than a third of these troubled companies have required an equity injection from their private equity owners.
Seven in 10 have used their revolving lines of credit, while almost a third have accessed the $670bn Paycheck Protection Program, the US government loan scheme designed to ensure small businesses keep workers employed during the pandemic.
Private equity-owned companies have also tapped the various stimulus programmes devised by the US government. Grants worth $275m and loans worth $87.5m have been awarded to managers including Blackstone, KKR, Apollo and Thoma Bravo, according to the Good Jobs First, a Washington-based consultancy.
As coronavirus continues to rage across the US and Europe, rating agencies are forecasting that defaults on highly leveraged private equity-owned companies will increase, weighing down on future returns for private equity funds.
“More widespread downgrades of underlying portfolio companies could translate into weaker PE fund performance,” said Nathan Flanders, managing director of financial institutions at Fitch.
He added that ratings downgrades for PE-owned companies could also create “lasting reputational risk” for alternative investment managers as well as “increased political and regulatory scrutiny” of their business model.
