PLANSPONSOR - June/July 2020 - 37

DB FOCUS
really up for discussion. It's all about what
fees investors pay for that performance.
Fees can absolutely destroy returns and
make private equity not worthwhile. "
The 2020 markets may prove an
exception, however. Pitchbook, a unit
of Morningstar that follows private
market investing, highlights the large
portfolio-markdown-anywhere from
9% to 22%-that five large managers
of publicly held private equity called for
in this year's first quarter. " Anyone with
exposure to energy investments has had
brutal markdowns, " Cawkwell says, " but
at other managers we're seeing average
markdowns of 8% to 10%, comparable to
the drop in the S&P 500. "
Private equity consultants at
Cambridge Associates, reaching out to
clients through " in-home " videos they
have made, have urged clients to temper
their expectations on portfolio valuations.
" The underlying business fundamentals
have just started to be affected by COVID19,
over the last few weeks of the quarter, "
says Josh Zweig, managing director at the
firm, in Boston. " The impact will wind up
being manager-specific [-i.e., related to
the manager's industry] sector [and] how
aggressive the general partner has been
in marking the portfolios. ... We will likely
see a wide dispersion of declines. On the
whole, we would expect the first quarter
to be more modest, followed by a more
dramatic decline in the second quarter.
" We believe general partners are
likely being too optimistic about the pace
of recovery as we come out of this, " Zweig
adds. " For instance, the GFC [global financial
crisis] saw seven quarters of private
equity valuation declines. ... It took another
eight quarters for those funds to fully
recover. We're in quarter one of this crisis,
and the fact is that nobody knows what to
expect. ... But we do expect a longer and
more severe downturn than what many
general partners are communicating. "
Thus, private equity investors are
standing at a seismic fault line, riven by
COVID-19. On the near side of the fault
U.S. Private-Equity vs. U.S. Public-Equity Markets
Annualized returns as of December 31, 2019
S&P 500
35%
30%
25%
20%
15%
5%
10%
1-year
3-year
5-year
10-year
15-year
*The U.S. Private Equity index is a horizon calculation based on data compiled from 1,551
funds-including fully liquidated partnerships-formed between 1986 and 2019.
Private indexes are pooled horizon internal rate of return (IRR) calculations, net of fees,
expenses and carried interest.
Note: Outperforming indexes are indicated with
Source: Cambridge Associates
.
are the portfolios of investments already
made. " The companies you already have
are likely to be hurt, " Friedberg says. " If
they are in distress and breaching their
debt covenants, they will be marked down.
" But if managers have dry powder,
that effect will be lessened considerably, "
he adds, " and there will be great opportunities
to grow existing businesses through
acquisitions or other strategic moves with
the influx of capital. "
On the far side of the COVID-19 fault
are the investments yet to be made. " There
aren't any discounts in equities, " Cawkwell
says. " Warren Buffett has said he sees
NEXT STEPS
* Discuss with your managers the flexibility of your private equity
strategy and ability to respond to a range of economic scenarios.
* Ask managers how they are dealing with the current environment's
reduced scope of due diligence.
PLANSPONSOR.COM June - July 2020 37
nothing to buy today, and we don't either.
" The markets are more optimistic now
than they were in 2001, after September
11, " he says, " but it feels like the economic
events are worse today. My guess is there
will be a trend down in equity prices in
six or 12 months, and that will be the real
opportunity for the private equity groups.
" There will be material changes
ahead, " Cawkwell continues. " But private
market managers are skilled at change
management, and any time change is
needed quickly, and an infusion of capital
and expertise is helpful, that's when private
equity managers make money. " -John Keefe
Russell 2000
Cambridge Associates U.S. Private Equity Index*
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