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August 13, 2020

The Case for Private Equity Investing Amid the Crisis

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The Case for Private Equity Investing Amid the Crisis

The Case for Private Equity Investing Amid the Crisis

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August 13, 2020

 
 

As companies around the world reel from the unprecedented disruption of the coronavirus pandemic, private equity may emerge as a source of capital uniquely suited to help businesses weather the storm, while, in turn, putting money to work in transactions at favorable valuations.

 
 

Given their long-term investment horizon, private equity firms may be well-positioned to help businesses seeking a path to economic recovery, making opportunities to invest in the asset class more attractive than they’ve been in years, according to Neha Champaneria Markle, Managing Director at Morgan Stanley Investment Management’s AIP Private Markets, which invests in private equity funds, co-investments, and secondaries, and manages $12 billion in assets1.

Private equity firms typically invest in companies by either acquiring or providing financing to them, with an aim of driving financial return on invested capital during a period of several years. Investor interest in these firms has steadily grown since the global financial crisis in 2008, as allocators have sought differentiated sources of return, compared with public equities or low-yielding debt. During the past 20 years, through December 2019, private equity funds returned 11% on an annualized basis, compared with 6% for the S&P 500 Index.2 While commitments to private equity reached record levels in 2019,3 the number of private companies, which is the opportunity set for private equity firms, is greater than ever before in the United States.4 In contrast, the number of U.S. publicly listed companies fell by 37% from 2000 to 2017, amid increased regulation and consolidation and the emergence of private equity capital as an alternative to public markets.5

As private and public companies alike face coronavirus disruptions to their workforces, supply chains, and revenue streams, demand for the flexible patient capital offered by many private equity firms may outstrip supply, Markle says. A similar dynamic characterized prior cycles, which show returns for private equity commitments made following global crises outpacing those made during other periods. Private equity returns are measured based on vintage year, often defined as the year in which a fund begins making investments in underlying companies. In the past two decades, funds that started deploying cash following a crisis (such as 2001 to 2004, after the dot-com bubble burst, or 2009 to 2012, after the global financial crisis) performed 68% higher than funds whose vintage years fell during late-cycle peak economic growth (such as 1998 to 2000 or 2005 to 2007).6 This may be due, in part, to private equity funds getting more favorable deal pricing during market downturns.

 
 
 
 
 

Private Equity Investment Opportunities

Market dislocations caused by the current global health crisis are likely to create a new set of private equity opportunities, Markle says, especially for investors such as AIP Private Markets that has deep experience investing in, and alongside, private equity managers that focus on small- and middle-market companies. Since its inception in 2000, the team at AIP Private Markets has committed nearly $20 billion to over 900 private equity transactions.7

As COVID-19 roils some industries and regions more than others, individual fund returns in private equity may show greater dispersion than prior to the pandemic, potentially enabling investors to identify managers that pursue more recession-resilient investment approaches, Markle says.

As an example, data suggest that single-sector private equity funds were over three times more likely to perform in the top quartile than generalist managers following the global financial crisis,8 and since then, the number of funds that specialize by industry has increased, offering more options for targeted investing, according to Markle. “Now, you have a deep market for single-sector specialists,” she says. “We look at these funds for the potential to get diversified long-term returns based on a specific theme.”

The pandemic has also pushed investors in private equity funds to be more discerning overall. That means differentiating between fund managers who aim to create value for businesses by supporting profitable growth, either organically or through acquisition, professionalizing processes and systems and enhancing management teams, versus funds that rely more on leverage, or borrowing money, to boost returns. While using debt can amplify performance for a private equity firm and its limited partners in the short term, critics say that aggressive use can increase risk particularly in times of stress, ultimately depressing long-term performance.

“We look at leverage multiples and have the ability to distinguish which managers emphasize operational value creation over financial engineering,” Markle says. “There are many managers in the industry that are committed to generating outperformance for investors by identifying and enhancing growth.”

 
 

1 As of June 2020.

2 https://www.cambridgeassociates.com/private-investment-benchmarks/Past performance is not indicative of future results.

Source: Pitchbook 2019 Annual U.S. Private Equity Breakdown. Data as of December 31, 2019.

4 Number of U.S. Companies includes firms with >20 employees, based on data from U.S. Census, Statistics of U.S. Businesses, as of March 2020.

5 Number of U.S. Publicly Listed Companies data as of June 2020 from The Global Economy.

6 Source: Preqin; data as of May 2020 for December 31, 2019 values. Past performance is not indicative of future results.

7 AIP Private Markets data, as of June 30, 2020.

8 Source: Preqin, AIP Private Markets. Most recent performance data as of June 30, 2016. AIP Private Markets made the specialist/generalist determination based on available industry data and AIP Private Markets’ proprietary knowledge. Specialist managers have a specific industry in which they invest while generalists have a wider scope of target industries.

 
 

Risk Considerations

Alternative investments are speculative and include a high degree of risk. Investors could lose all, or a substantial amount, of their investment. Alternative instruments are suitable only for long-term investors willing to forgo liquidity and put capital at risk for an indefinite period of time. Alternative investments are typically highly illiquid—there is no secondary market for private funds, and there may be restrictions on redemptions or the assignment or other transfer of investments in private funds. Alternative investments often utilize leverage and other speculative practices that may increase volatility and risk of loss. Financial intermediaries are required to satisfy themselves that the information in this document is suitable for any person to whom they provide this document in view of that person’s circumstances and purpose. The Morgan Stanley Alternative Investment Partners Private Markets (“Morgan Stanley AIP” or “AIP Private Markets”) Team shall not be liable for, and accepts no liability for, the use or misuse of this document by any such financial intermediary. If such a person considers an investment she/he should always ensure that she/he has satisfied herself/himself that she/he has been properly advised by that financial intermediary about the suitability of an investment.

 
 
 
The AIP Private Markets team provides investors access to broadly diversified and thematic multi-manager portfolios, secondaries, co-investments, impact investing strategies and custom solutions.
 
 
 
 
 

IMPORTANT INFORMATION

The information contained herein refers to research, but does not constitute an equity research report and is not from Morgan Stanley Equity Research. The views expressed herein are those of Morgan Stanley Alternative Investment Partners Private Markets (“Morgan Stanley AIP”) as of March 2020 and are subject to change at any time due to changes in market and economic conditions. The views and opinions expressed herein may differ from those of other Morgan Stanley affiliates or businesses. The views and opinions expressed herein are based on matters as they exist as of the date of preparation of this piece and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date hereof.

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There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. There are important differences in how the strategy is carried out in each of the investment vehicles. Your financial professional will be happy to discuss with you the vehicle most appropriate for you given your investment objectives, risk tolerance and investment time horizon. This piece has been prepared solely for informational purposes and is not an offer, or a solicitation of an offer, to buy or sell any security or instrument or to participate in any trading strategy. The material contained herein has not been based on a consideration of any individual recipient circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, the recipient should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.

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Persons considering an alternative investment should refer to the specific investment’s offering documentation, which will fully describe the specific risks and considerations associated with such investment.

Alternative investments are speculative and include a high degree of risk. Investors could lose all, or a substantial amount, of their investment. Alternative instruments are suitable only for long-term investors willing to forgo liquidity and put capital at risk for an indefinite period of time. Alternative investments are typically highly illiquid—there is no secondary market for private funds, and there may be restrictions on redemptions or the assignment or other transfer of investments in private funds. Alternative investments often utilize leverage and other speculative practices that may increase volatility and risk of loss. Financial intermediaries are required to satisfy themselves that the information in this document is suitable for any person to whom they provide this document in view of that person’s circumstances and purpose. The AP Private Markets Team shall not be liable for, and accepts no liability for, the use or misuse of this document by any such financial intermediary. If such a person considers an investment she/he should always ensure that she/he has satisfied herself/himself that she/he has been properly advised by that financial intermediary about the suitability of an investment.

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Risks Relating to Private Equity Investments. Certain funds will typically invest in securities, instruments and assets that are not, and are not expected to become, publicly traded and therefore may require a substantial length of time to realize a return or fully liquidate. The respective general partners cannot provide assurance that they will be able to identify, choose, make or realize investments of the type targeted for their fund, or that such fund will be able to invest fully its committed capital. There can be no assurance that a fund will be able to generate returns for its investors or that returns will be commensurate with the risks of the investments within such fund’s investment objectives. The business of identifying and structuring investments of the types contemplated by these funds is competitive and involves a high degree of uncertainty. In addition to competition from other investors, the availability of investment opportunities generally will be subject to market conditions as well as, in many cases, the prevailing regulatory or political climate. In addition, investments in infrastructure may be subject to a variety of legal risks, including environmental issues, land expropriation and other property-related claims, industrial action and legal action from special interest groups.

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