A private markets perspective on the pandemic in 2020 and beyond
December 9, 2020
What a difference a year makes.
At this time in 2019, initial reports of a novel virus to be called COVID-19 were just beginning to come out of China, and the pandemic was still months from becoming front-page news around the world. Investors were busy instead planning for another regular year in 2020, setting return targets, selecting strategies and sourcing opportunities.
By mid-March 2020, everything had changed. Entire economies shut down, uncertainty about the future roiled public markets, and everyone immediately began transitioning to a world in which Zoom calls, masks and social distancing were the new reality. Certain sectors demonstrated resilience, whereas others, including retail, hospitality and transportation, were more severely affected.
While no one had expected a global health crisis, many players recognized we were already late in the current economic cycle. Even before the onset of the pandemic, private investors had been preparing for a market correction. Many were already focused on investing in high-quality companies positioned to deliver more stable performance despite the challenging economic and business environment.
In the early days of the pandemic, private markets managers responded defensively. They shifted their focus almost entirely towards their existing portfolios and the liquidity needs of their portfolio companies. Just as in public markets, uncertainty abounded, and the unfolding crisis affected portfolio company revenues – in some cases, severely so.
One key difference in the private markets, however, was that managers are directly and actively involved in the companies and assets in their portfolios. This hands-on approach, along with access to committed pools of capital, allowed them to react quickly, support portfolio companies’ immediate needs and prepare for the road to recovery.
If 2020 was all about “defence,” ensuring that portfolios stabilized and the underlying assets had what they needed to continue to operate, 2021 looks poised to be a year of playing “offence.”
Like prior crises, COVID-19 has created significant opportunities, including the potential to source quality assets from motivated sellers dealing with liquidity challenges. We expect private markets investment firms will focus on businesses positioned for sustainable long-term growth, value-added asset management initiatives, and secondary market transactions offering advantageous pricing and strong risk-adjusted returns.
In private equity, investment activity increased considerably through the third and fourth quarters, with new M&A processes launched, as well as the resumption of processes put on hold at the onset of the pandemic. There are clear benefits to a private equity strategy focused on creating diversified exposure to private company value creation. Heading into 2021, we believe private equity could generate similar outperformance to that seen in prior downturns, driven by more attractive purchase valuations that can result from market uncertainty.
There’s also demonstrated improvement in private credit. The leveraged loan market performed well in the third quarter, with new issue activity increasing and secondary pricing extending its recovery. Market dynamics are, on balance, starting to favour lenders. However, there’s still an abundance of capital competing for preferred borrowers in resilient industries, and pricing and structuring for these opportunities remains competitive. Overall, we expect continued improvement in deployment opportunities for investors seeking attractive floating rate returns and reliable income.
Infrastructure also continues to be a focus for institutional investors. Contracted infrastructure assets, with revenue streams that are less sensitive to broad, macro-economic factors are well positioned to perform in the current environment. Other infrastructure assets are starting to see a recovery in demand, with volumes increasing as economies take steps towards reopening. It’s also worth noting that in the U.S., a significant new wave of infrastructure spending is expected following the November presidential election, which should result in new opportunities for investors seeking exposure to the asset class.
In the new year, investors should continue to view their private markets strategies with a long-term perspective. The pandemic has shown that diversified allocations to private markets provide investors with lower volatility in uncertain markets. We believe the year ahead will be a highly compelling time to access new opportunities, and that maintaining consistent allocations to private assets can deliver strong returns. This is particularly true in periods characterized by market dislocation and volatility, which can lead to attractive valuations and investment opportunities for patient investors with available capital.
Jeff Pentland is a managing director at Toronto-headquartered Northleaf Capital Partners, a leading global private markets investment firm with more than US$14 billion in private equity, private credit and infrastructure commitments. These views are those of the author and not necessarily those of the Canadian Investment Review.