Coronavirus: European LPs contemplate course corrections

Over the last two years, Unquote has often asked key players in the institutional investor and private equity communities if they foresaw any bumps in the road ahead and when the next crisis would erupt, given that the financial world was seemingly nearing the end of a cycle after eight years of growth. "I wish I had a crystal ball to answer this question" was a common response.

But when travel bans were imposed and offices started closing down in March, it was clear a crystal ball would not be needed anymore.

The Covid-19 outbreak had a near immediate effect on LPs' ability to assess investment opportunities. "We are unable to visit managers onsite. This hinders us in our due diligence requirements. For now, this results in a challenging situation for new commitments. Despite this, we're still actively executing our due diligence from our desk at home currently," says Dick Tol, a portfolio manager at Pensioenfonds PGB.

Others are finding ways to progress work streams as much as is feasible. Swedish pension fund AP4 is still looking to close some opportunities during Q2, with its alternative investments team continuing business as usual as much as possible, says senior portfolio manager Hanna Ideström. She adds that the LP has converted planned meetings to video meetings, instead of physical meetings, for advanced due diligence processes.

"With the speed at which countries have locked down populations across the globe, it has really tested organisations' business contingency plans and location strategies," says Mike Dickey, global head of product at MUFG Investor Services. "Organisations that are not appropriately set up for robust remote working practices may be exposed as they try to adapt to new working conditions while dealing with regular-service-level deliverables and quarter-end processes for their clients. Additionally, providers with significant presence in low-cost jurisdictions will face challenges as remote working and local infrastructure may not be set up or in a mature state to support the demands required."

Assessing the known unknowns
Of course, the practicalities of remote working are just the tip of the iceberg. The global financial crisis is a reminder that more bankruptcies, unemployment, liquidity concerns, project cancellations, economic uncertainty and political instability are on their way.

These previous events had significant regulatory and strategic ramifications for financial institutions. But LPs are not unanimous in their opinion of how the current pandemic will reshape ways of thinking. "Covid-19 may lead to more attention to real-world risks and outcomes," says Piet Klop, senior adviser responsible investment at PGGM. "Or it may not, and may reimpose a short-term investor mindset. Time will tell whether and how this will affect different private markets."

Mikael Falck, head of alternatives at Kåpan Pensioner, also agrees it is too early to assess the long-term impact of Covid-19, highlighting that the LP is not currently altering its strategy or allocation to private markets: "It is too early to assess return implications. Private markets follow a quarterly reporting scheme, so even just the impacts of Q1 2020 will not be known until April or May. What we can envision are the most obvious sectors being hit the worst in the short term, regardless of asset class, including oil-price-sensitive energy, transportation, mostly air-traffic-related, and the hospitality sector at large, especially tourism."

PGB's Tol anticipates that prices will come down, and, as the Dutch pension fund is in a young private equity programme, its underlying GPs are expected to be able to acquire businesses at much better prices compared to a couple of months ago.

"I think inevitably there will be a downward impact on valuations and a slowdown in realisations," says MUFG's Dickey. "We have already seen several clients delay new launches. When you look back at the global financial crisis, this is what happened. In the current environment, it appears that the impact is more immediate and potentially more damaging to the operating companies that firms invest in. Given that most assets are valued once or twice a year, it will be interesting to see how firms reflect these impacts in their valuations. I suspect those investments with weak cashflow will struggle the most. We have seen our asset manager clients draw heavily on financing for liquidity, which may help managers' returns in the short term."

Pivoting to new opportunities
LPs will also search for silver linings in the current environment, and opportunities to pivot quickly to adapt to the new landscape if and when the situation stabilises. The last global financial crisis triggered a sell-off of illiquid assets from large pensions and institutional investors to meet allocation requirements and offset losses in the liquid portfolios, often creating more losses, according to Dickey. "Given the increased allocations to private markets in the last decade, it will be interesting to see how LPs react this time, and whether they have addressed how they deal with allocations to avoid compounding losses. Given that private markets tend to have longer return horizons, they may be better placed to weather the storm."

For AP4, areas of opportunity include secondaries and distressed investments. The pension fund is looking to keep its long-term strategy in private markets unaffected, despite the current challenge.

"AP4 is a long-term investor in the financial markets, and is able to take a long-term view even in these turbulent times," says Ideström. "Our long-term strategy is unaffected in real assets, as well as private credit and private equity. However, we think opportunities could materialise within, for example, secondaries or distressed assets, which we would then actively evaluate."

Brunel Pension Partnership also sees opportunities in secondaries. "We have specifically sought out the maximum permissible weighting in PE secondary funds to take advantage of pricing movements and appointed a manager to source tactical infrastructure co-investments for our clients," says Mark Mansley, chief investment officer at Brunel Pension Partnership.

"Given the majority of our clients' money committed via Brunel is still dry powder, we believe our selected managers are well placed to deliver or exceed the anticipated returns, but only time will tell," says Mansley. "Thus far, money in the ground is in assets that are resilient, although clearly not immune to the rapid and dramatic impacts of the virus." 

Financial crises, much like viruses, have incubation periods, peaks, and end dates. But they also have a tendency to resurface, leading some LPs to advocate for more awareness of the warning signs and better preparedness for an uncertain future. This includes targeting investments that are not only providing returns, but also impact from an environmental, social or governance (ESG) point of view.

"We believe that Covid-19 is bringing to the fore how important sustainability of investments is, as shown by the huge decline in oil prices, fossil-fuel-powered energy, and transport," says Mansley.

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