PE Investment Activity Amidst Spiraling Markets
Hope all are staying safe, esp those of you in covid hotbeds like NYC. Now that the major indices are down ~35% and prices have come down, I'm curious how active the PE guys are in putting capital to work (esp in light of the record amount of dry powder raised in the past few years and a repeated complaint during those years being "prices are too high"). Across buyout, minority, distressed, etc. Are you doing deals currently? Or are you waiting for some more carnage or certainty wrt a vaccine/treatment? Any insights you're able to share would be appreciated.
Everyone is working on making sure their portfolio companies are fine. Most firms have put deals on hold.
Focus for now is - as others have mentioned - on the portfolio, so the team members with PortCos are focused on i) keeping those afloat and ii) if secured, then pursue value creation opps for those (cheap add-ons, market share gain, etc) => invested money usually comes first in those times.
We have set up separate teams that are not doing any portfolio work that now do systematic screening of assets that are on the wish list for a long time but were simply not actionable / too expensive, that could now be in the strike zone for a buyout or just simply need some capital in this temporary shock (minority invest).
Wouldn't expect too many deals in the near term (i.e. coming weeks) as sellers still want yesterday's price while the buyers are offering today's / tomorrow's price but once the situation stabilises (albeit likely at low levels), there should be some activity. At the same time there will be some deals to be made right now of course, for companies needing money now and not tmrw but not all PEs are there to strike those.
I think the one other thing to remember if things keep getting worse that PE funds will have a tough time getting deals done (I will ignore the whole PE is people intensive thing because that is beyond the scope of this post).
Why may PE funds have a tough time doing deals and buying low? I mean isn't that the point of dry powder? Absolutely! BUT because that money they have to invest comes from somewhere. That somewhere is institutional investors. Remember that institutional investors have large portfolios and PE is not usually their biggest allocation. And also as allocators, sick fast downwards moves like this (in which there is a rush for cash and traditional assets haven't dampened vol that much) will not only screw up their portfolio allocations but remember that investors often have their own issues.
Many of them have to pay out about 5% of their fund into whatever cause/issues (pension disbursements, college expenses etc) and so with their liquid values taking a huge hit AND having to disburse that capital, can mean that although they are legally obligated to meet capital calls (ie PE fund wants to invests, calls capital from its investors), they may ask/beg the PE fund not to. This happened more than a few times in the GFC. Deals were either put on ice, or guys got bridge loans or some investors were cut out of deals, or committed capital later on (at a price of course).
The best way to imagine it is if you are an endowment and 60% of your money is in equity and 40% in fixed income. Markets are down like 30%. Well your equity (or the public part of it) is now worth 42 and fixed income is worth 40% (let's assume fixed income didn't move - ambitious I know...). BUT you also have to pay out 5% a year to contribute your share of the college/university's costs. So your portfolio is now worth 77. (60*.7 + 40 - 5). In a downturn you probably won't get as generous inflows and contributions from alumni, since well, the market is down and they are also feeling the pain. So let's say your inflows are 0 (once again, unrealistic but bear with me). You will have to pay out of cash or sell some assets to disburse that 5 percent. That means redeeming from some hedge fund/mutual fund/etf etc since private assets are tougher to sell. If you are redeeming and there are more than one of you and given you are an institution, you are a SIZE investor, guess what that effect has on underlying managers (HFs, Mutual funds, etfs etc). Now imagine that you are not the only institution that thinks that way, because well, most of them think alike.
Now at a total portfolio value of 77, your fixed income portfolio is more than half the portfolio which has screwed with your allocations. Hmmmmmm. Alumni, the board, whoever, kind of understand, but they don't because well, isn't it YOUR JOB to keep those allocations in check and manage through volatility? So hoping for the rebound and to put off redeeming from investments or to do so orderly in other parts of their portfolio, investors will ask PE funds to hold off on a capital call or to join in the deal later at a cost (the GP funds it, finds a bridge loan, another LP steps up etc). However, when everyone is suffering...
Now one can say, well investors are legally bound to honor capital calls. They are. Let's say a GP enforces that. Well now, when it comes time to fundraising the next time, said PE firm probably won't get a commitment from that investor. Investors also talk, they have very long memories, since well, they are (in theory) long term investors (which frankly PE/HFs etc arent, regardless of their marketing schpiels). Investors also move to other places. It's a very relationship driven business.
Just another angle for folks to think about here and hope that this helps.
Good Luck
This is so pleasant to read and so very true. Everything contaminates.
The other thing, and having worked in PE after working in markets gives me a nice little insight: the fund I was at was a mega fund that needed to deploy. That means they bought all the POS assets that were laying on the market at over-inflated valuation. The fund is more than halfway invested in dog shit, you know what's going to happen? They'll be having to deploy their dry powder just to keep assets afloat. The guys who are lucky, are the ones who just finished their capital raise, but then again see comment above.
I haven't even discussed financing markets, where no lender is willing to land at the moment. Also there is still no real distress, just yet.. Everyone is waiting for the bottom - but who the hell knows when the bottom will be? As most PE investors are risk averse (otherwise they wouldn't be working in PE anymore) and like to hold on to their job, it's not their "job" to time the market - so they'll sit on the side and wait. Also on paper they might look like the funds are doing ok - but that's only because the mark to market only happens every year and you can bull shit the hell out of the big 4 when it comes to valuation exercises.
One or two guys with enough balls will go in first at the right time and they will rip the benefit. But this is a tiny minority.
S&T desks PnL will depend on the product, flow and people. I am certain convertibles desks (and many funds) are getting absolutely crushed. I understand that at least one single stock vol desk is getting hammered, but that the exotics and structured guys literally across the screen or a few seats down are killing it. I cannot comment on other products, such as rates/fx but if you are in credit and you have inventory, you are probably marking that down a lot. Like daily. EM desks probably tough to since those are less liquid and your clients are all moving one way.
Banks will then make the argument that much of said PnL was thanks to the firm's franchise, standing with clients, balance sheet (all are related/kind of the same thing), rather than prop positioning, since that is well, not really allowed anymore (wink wink at some firms). This is not necessarily incorrect. Want to try your hand at really managing risk and being on your own? Go join a hedge fund and good luck - most fail, ha ha... We will hire some other Associate to Director level guy from another bank or off the street who has been looking for a while to trade for us, and mostly agency. Oh and by the way, your desk has 5 guys? That needs to be cut to 4 or 3. I know it used to be 10, but see how you guys made decent pnl with just 5 guys? Less is more. Junior is better. Oh we are going to stiff you on a decent bonus because, well, we think that much of the PnL was flow and franchise and anyone could make that. And because you haven't generated much revenue in the good times. You know hedge funds just aren't as profitable clients and the market is so over-broked so spreads are thing... So thanks for your contribution this year. Here is a flat to down bonus, because, well you've seen how the rest of the bank has done. But the upside is that you got something and got to keep your job! For now. Enjoy?
The world has changed. GS across the board still does a fair bit of prop from my experience dealing with them, but it is not truly formal like it used to be, like it was pre-crisis. And pre-crisis, if I am not mistaken I think well north of 70% of GS revenues came from "Securities" or "Sales and Trading" or whatever they officially called it. It's in the 10ks. If I am wrong about this, someone please correct me.
I will confess that I have never worked on a sell side desk. Part of my wants to just to do so, to really see how the beast really is. But all of my brokers and contacts do nothing but groan (and I understand why). In addition to much lower pay, status, and challenges in getting promoted, one can't take much risk, compliance is always on you, oh and your job is in perpetual threat from younger people, politics, management, computers, performance, you name it.
Much of the crapping on S&T isn't on the jobs or careers or people. It's the prospects. They just aren't there anymore.
I am older than most on this board and now understand that I was 10-15 years too late to the party. Any of you younger types are way beyond it. It's not a bad segway into the business and one can learn a lot, meet a lot of people and make some decent money, but it will be volatile, and as you go up, the risk/reward to continue just isn't there, so best to segway into something else. koalamacro has lots of great thoughts on the topic in other posts and so I won't steal his/her thunder.
In short, NO ONE I KNOW on any desk or any bank is really happy there. Literally. If anyone is content, it is because they have found solace in their life with family or other hobbies, rather than work. Which is seen just as that. Work. And that goes for social salespeople as well as guys who actually like trading and the market.
Good Luck
LP here from a mid-sized pension fund (~$40bn). Your comments ring true but I would add that there are some nuances between LPs, even among different pension funds. Pension funds who have a younger membership base and who don't have ability to switch funds may find it easier to navigate through any denominator effect as they will have more funds coming through from their young members. The flip-side is that such funds may have aggressively invested in illiquid assets given their young base so probably overly allocated to illiquid assets post decline in public markets. Funds who have older members may have less capital coming in and likely have a higher pay-out ratio too - hopefully they had asset allocation coming into this in more liquid and defensive assets to reflect base. The sad thing is that members who were on track to retire shortly would have seen a massive hit to their savings and may now face having to work longer or live on less (sequencing risk becomes more prevalent the older you get).
We are absolutely honoring the capital calls from our GPs and we continue to consider re-ups but not considering new names at this stage. We continue to pursue co-investments but the ones that are live are priced in the old world (consistent with above comment). We've seen some GPs preemptively call capital from LPs in fear that their own LPs are facing liquidity pressures. For the most part it seems everyone calling capital of late is doing so to pay down capital call facilities use for 2019 deals .
We're taking this opportunity to see how our GPs react and manage through as this will help inform our decision for the next re-up. There was a prior comment from an analyst above re. "but we have to do all this work for documentation purposes" - certainly hope you're trying harder than that given the jobs at stake at your portfolio companies. End of the day, we are trying to be supportive of our GPs since its in no-one's interest for the companies to go under (maybe except for the distressed folks). For funds that are fully invested but still have companies that need support, we're starting to see side-car vehicles being setup and we expect more rescue financing, fund extensions and single-asset concentration issues come up for discussion.
This is a great post (very interesting to hear about the side car vehicles) and certainly with much more nuance than mine (which was meant to be basic). I cannot recall if any LPs actually defaulted on capital calls during the GFC. I don't think any big ones actually did. But I heard directly from numerous GPs who would not name the LPs, who would literally call to beg to say "please don't call capital" or "give us some time." Once again, capital calls can be enforced, but you are literally biting the hand that feeds you (and that's a very long term income stream) and one that would have the be replaced in a future fund. Plus, LPs gossip. A lot.
I did just run across this though...
https://www.privatefundscfo.com/lp-defaults-already-happening-heres-why…