We have our fair share of challenges ahead. That is not in debate. But history shows us that unprecedented times can also be a strong breeding ground for opportunity. Our investment teams around the globe certainly believe this to be the case going into 2021 as they continue to balance ongoing risk assessment with strategic growth investing.
We are pleased to share their respective outlooks for the year and beyond.
Primary Investments
As we enter the new year, GPs are highly focused on evaluating market risk and are staying extra-vigilant, with many turning to learnings from past market dislocations that continue to resonate, including 1) revisit every assumption; 2) plan for recession case scenarios; 3) revise budgets frequently; 4) strengthen balance sheets with a focus on cash management; and 5) deploy operations teams aggressively to manage the portfolio. Despite these defensive measures, history shows us that the industry’s strongest returns are often generated in challenging times, where dislocation creates opportunity. Going forward GPs need to be selective when
making new investments and identify attractive return profiles in light of prevailing risk levels.
Private equity has always invested in the technology, consumer, health care, education, and business services areas, but the pandemic has evolved or changed the paradigm – causing us to consider new business models, consumer behaviors, and social norms. This “new idea” environment is creating an investment landscape that we believe could be ripe for value-added investments. We also expect to see continued acceleration in the adoption of technology and in the transformation of
sectors, with GPs becoming more focused on highly technology-enabled businesses.
As such, the opportunities in Asian markets could potentially follow a familiar pattern: buyout commitments focused more on developed markets such as Australia, Japan, and Korea, with venture commitments focused on China.
Secondary Investments
At the same time, COVID-19 has accelerated trends and reinforced views among many high-quality GPs that the secondary market is an important liquidity tool in their toolkits.
Entering 2021, traditional transaction volume is poised to decline from representing approximately 60% of the market in 2018/2019 to potentially just 40% in 2020.¹ This shift is being driven by both slowed
traditional transaction activity and explosive growth of the GP-led space (see below graphic).
While early, we expect overall transaction volume in 2021 to increase considerably from levels in 2020, and to perhaps exceed the record high in 2019.
By the end of 2020, secondary market pricing had bounced back from mid-year lows but
was still below pre-pandemic levels. The net result has been an attractive, robust investing environment for those buyers focused on the more non-traditional segments of the market.
This should be favorable for secondary buyers as it may enable even greater selectivity and may further increase the attractiveness of the supply/demand dynamic from buyers’ perspectives.
Expanding universe of secondary market opportunities
Shown for illustrative purposes only
Direct Co-investments
The current co-investment climate continues to be one of high valuations and leverage, as well as low interest rates for high-quality businesses. Similar to before COVID-19, GPs have significant amounts of dry powder which should translate into high investment activity in 2021 and beyond.
Looking ahead, we expect the most successful co-investors to focus on 1) solutions-oriented opportunities, 2) partnering with GPs with deep understanding of the
specific sector and assets, 3) structured transactions with downside protection, and 4) recapitalizations.
Also, we anticipate that certain industries will cycle differently as a new market normal evolves. For example, the restaurant, food service, and tourism industries will likely be hard-hit in the short term, while sectors such as collaboration software, tele-health and home health, online pharmacy, and telecom/internet will continue to carry this
growth momentum over the long-term. Within the broader health care sector, we see COVID-19 continuing to fuel trends in multiple health care sub-sectors, including virtual care adoption, value-based care model proliferation, and the on-shoring of pharmaceutical contract manufacturing. The crisis has also catalyzed ongoing paradigm shifts in health care provision in the areas of clinical trial virtualization and the Social Determinants of Health, creating compelling investment opportunities.
Private Credit
As for credit markets, lending conditions remain favorable as lenders continue to demand better pricing and lower risk metrics than before the pandemic. Key trends that we believe will drive credit market dynamics going forward include macro/political issues (i.e., economic resilience in the wake of COVID-19 or potential stimulus) and market-specific trends, including whether deal activity can remain strong. Some of the best opportunities for new deal activity could include:
- A continued focus on providing financing solutions to the best middle-market, sponsor-backed companies that show certainty of revenue, maintain a strong relative market share in core sector/industry, and offer a need to have (versus nice to have) product or service
- Aligning with the best sponsors in the best industries to create attractive margins of safety
- Incremental or add-on financing opportunities
- Secondary purchases
Within the sponsor-backed, leveraged buyout market we anticipate that demand for private credit will continue to be steady given the amount of dry powder available for equity investment.
Real Assets
Similar to other investment areas, COVID-19 has helped accelerate real assets and infrastructure trends, and in a way pulled the future forward. The first important trend is digital infrastructure, as our collective reliance on all things technology and digital grew stronger in 2020. Broadband usage, for example, doubled in parts of the world at the height of the lockdown. And with the desire for connectivity and reliability only increasing, digital infrastructure including data centers and fiber, are expected to play a growing role in investors’ real assets portfolios.
Additionally, as domestic energy usage has risen and more people have adjusted to working and living remotely, there has been an increased focus on renewable and sustainable energy sources. Against this backdrop, technological advancement continues to plow ahead, with price declines and increased government, corporate, and consumer support for renewable energy. Like digital infrastructure, renewable energy is expected to receive a bigger portion of institutional investors’ allocations.
Last, with local, municipal, and federal government budgets stretched, many governments holding infrastructure, energy, and natural resource assets may consider privatizations or public-private partnerships as a means to shore up balance sheets. This in turn could create opportunities for investors to continue to play a growing role in managing the globe’s critical infrastructure.