COVID-19 has taken a toll on nearly every investment arena, and private equity is no exception. Perhaps not surprisingly, exit counts, as well as overall fundraising activity, have diminished as compared to last year. Through the third quarter of this year, US PE deal activity registered 3,444 deals, accounting for slightly more than $450 billion. These values represented declines of 16% and 21%, respectively as compared to this time last year.
While these more macro trends are somewhat expected, other trends are more nuanced and many offer much hope for 2021.
Shifting areas of focus
According to a recent report by S&P Global, PE firms have diverged in terms of their areas of focus over the past couple of months. Whereas at the beginning of the pandemic, PE firms were laser-focused on stabilizing their existing portfolios, they have since shifted focus. Increasingly, PE firms are shifting to making new selective investments “likely in order to take advantage of low-asset valuations in certain sectors”, according to the report.
Now, only the minority of PE firms are focused on stabilizing their current portfolio, with this percentage being lowest in Asia-Pacific (14%) and highest in Latin America (39%). Fundraising remains a more minor focus, highest in Middle East & Aric (13%), Europe (12%), and North America (11%).
Data as of 1/9/20. Source: PE Mid-Year Survey, S&P Global Market Intelligence. For illustrative purposes only.
A recent report by PitchBook sheds light on nuances in terms of how PE firms are making investments. In particular, the shift to virtual communication has compelled LPs to conduct due diligence via teleconference. Telecommunication, according to the report, favors established managers, which is reflected in the data—the median PE fund size has increased as compared to last year. This trend may not last long though. According to the PitchBook report, “LPs are figuring out ways to better vet newer small managers, meaning these GPs may find more success in 2021, even if the lockdown persists.”
PE firms are increasingly making bold commitments to environmental, social, governance (ESG) standards . As reported by ThinkAdvisor, Larry Fink, CEO of BlackRock, recently committed to ensuring 100% of its portfolios will integrate ESG metrics by the end of 2020, representing a sharp from 70% at the end of April 2020.
Experts expect others to follow suit. Anna Grotberg, an associate partner at EY-Parthenon, has explained that she’s also seen an increased emphasis on developing ESG policies by private equity firms. She explains,
So my personal opinion, based on the conversations over the past few months, is that this real sense of purpose and responsibility that has been on the agenda is being accelerated right now...We’ve had increasing demand from [limited partners] in terms of transparency and accountability, particularly around [environmental, social and governance] and ESG policies.
The ThinkAdvisor report offers additional color in terms of why we might see PE firms double down in terms of their ERG commitments. It explains,
Investment companies are adopting ESG policies for practical reasons as well. Decreasing utility bills and focusing on energy efficiency are the cornerstones of ESG, and in the light of the pandemic, these policies can be effectual methods of saving.
Considering second- and third-order effects
PE firms are starting to look beyond first-order effects so as to assess what second- and third-order effects might emerge in the aftermath of the pandemic. To be sure, these effects are wide-ranging. As reported by McKinsey, “Over the long term, autonomous vehicles, micromobility solutions, and other technologies that support physical distancing could benefit.”.
One especially important second-order effect relates to racial and gender equity. As the report explains,
One second-order effect across industries has been to cast an intense spotlight on racial and gender equity. As PE companies seek to improve their record on these issues, they might consider the correlation between the financial performance of companies and the racial and gender diversity of their executive teams.
McKinsey has drawn on expert interviews to identify ten themes—and associated first- and second-order effects— that are most likely to affect PE investors. One prominent theme relates to shifts in consumer preferences from value buying and a focus on safe and trusted brands (first-order effect) to a focus on loyalty management (second-order effect) to analytics-driven hyperlocalization and personalization (third-order effect).
Private equity firms have weathered tough storms over the past year. But there’s a lot of reason for hope. According to a recent latest analysis from the CEPRES Investment Platform, 2021 might just be the best year for private markets yet. The trends discussed here will likely play important roles in determining just how successful 2021 for PE firms.