Industry's lack of transparency may keep investors in the dark on how they've been affected by COVID-19 stress
By offering exposure to asset classes and strategies that aren’t correlated to public markets, alternative investments have promised to be a valuable form of portfolio defense in times of volatility. Some segments have so far delivered. However, others might not be as immune to market stress — and it could take some time before they show symptoms.
“When there’s a quick downturn like this, [private equity investments] won’t get marked for two months,” Brad Alford, who founded search consulting firm Alpha Capital, said in an interview with Institutional Investor.
According to Alford and other investment professionals, private equity firms need time to revalue their assets, and that’s aside from their usual post-quarter work. The methods behind managers’ revaluations aren’t clear either, leaving limited partners to make their own assumptions until the actual numbers come through.
Institutional Investor cited Preqin data released on March 31, which said that investors can expect “muted returns” for buyout funds that are vintage 2012 to 2017. As assumptions on net multiples and internal rates of return are re-examined, exit valuations and timelines will also be affected, according to the data firm.
Projections on the potential losses are varied, with one data provider advising clients to use a 10% value at risk metric, and one online secondaries marketplace forecasting “20 to 40 percent discounts overall compared to pre-coronavirus pricing.” But experts suggest that many PE fund managers are planning to spread write-downs over two quarters to smooth their portfolios’ return performance.
Depending on how long and deep the current economic crisis will go, today’s younger equity funds could chart a path similar to the one traced by those that existed during the dot-com bubble burst and the 2008 financial crisis. But according to Alan Kosan, senior vice president at outsourced-CIO firm Segal Marco Advisors, things are different from the global financial crisis, which had a financial-sector meltdown as its epicentre.
“Now the financial sector .. [is] well-capitalized, well-regulated, and they have cash on hand,” Kosan told Institutional Investor, noting the more systemic nature of the coronavirus pandemic followed by a precipitous drop in the markets. “It's not that you can look at cleaning up the financial sector and going back to normal.”
A similar problem might be seen in Canada’s private-debt industry, which is financed considerably through shadow banking. In a column published by the Financial Post, Martin Pelletier of Wellington-Altus Private Wealth Counsel noted that players in the private debt and mortgage markets don’t regularly and consistently mark their assets to market.
“Ironically, because of [this], many private funds have been reporting a linear return profile that consequently offers a so-called ‘low correlation’ to the traditional portfolio,” he wrote. “This works until a large event happens like this one sending the mortgage market into complete chaos and putting asset prices very much at risk.”
Citing a Canadian Bankers Association report, Pelletier noted that almost half a million Canadians have asked for mortgage deferrals and skipped payments in just the past two weeks, with the Big Six banks deferring over 10% of the mortgages in their portfolios. Canada’s public REITs, he added have sold off by nearly 30% this year, and higher-risk publicly listed lenders are down 50% to 60%.
“So ask yourself, how are the smaller private mortgage and debt investment corporations going to fare in this type of environment?” he said.