Private Equity Not Immune To Covid-19 Impact
Much of the analysis of alternative investment performance during the current market drawdown has, understandably, focused on hedge funds; this is hardly a surprise, given that much more investment performance data is available for these products than private equity funds. We touched on the topic of private equity previously, looking at its diversification benefits last year (finding that it leaves much to be desired) and at its performance vs public equities as recently as one month ago, finding that most outperformance in the industry came from the early days, and in recent years PE has been trending on par with public equity markets.
Therefore, an obvious question presents itself; can such a pattern continue? And the COVID-19 crash has apparently brought us an answer, whether we like it or not: the S&P Listed Private Equity Index is crashing faster than the S&P 500 index.
According to the S&P website, “The S&P Listed Private Equity Index comprises the leading listed private equity companies that meet specific size, liquidity, exposure, and activity requirements. The index is designed to provide tradable exposure to the leading publicly-listed companies that are active in the private equity space.” It is currently 16% lower month-to-date than the S&P500, possibly due to investor fears that private equity portfolio companies have too much leverage and might not be able to meet their repayment obligations in the event of a significant downturn in revenues (and certainly not if they go out of business).
The dynamics of the recent stock market plunge, listed private equity or otherwise, is unprecedented, and looking at the daily returns chart, equities look like a machine running increasingly out of control. Ever seen those videos of cars skidding off an icy road? It starts slowly, then a bit of drift to the left, then a bit compensation to the right, then more to the left, even more to the right, and before you know it the car is in a ditch or the side wall.
Equity market returns are moving in a very similar pattern and if physics teaches us anything, it is that such dynamics cannot continue much longer before hitting a financial ditch (markets halted indefinitely) or a side wall (the financial system coming apart with nuts and bolts flying around). Brining this system under control requires a lot of skill and, at this stage, a large portion of luck, and the question is - what is next?
The control measures are, obviously, the stimulus packages, being discussed and implemented by practically all governments and central banks of the world right now. But there lies the challenge - if the measures are not enough to stabilize the economy, it crashes. If they are overdone (and this is how it is shaping right now with unlimited QE and Fed bond purchases) then we risk insane levels of hyperinflation. What are we going to buy with all that money if there are no products being manufactured and the supply lines are broken?
Whether is it “private” or “public” equity, we are all in the same boat right now, and need to start collectively and proactively thinking about ways of *exiting* the crisis mode, beyond carpet-bombing the virus with total shut-downs and helicopter money. We will keep an eye on the situation and update you when we see interesting patterns evolving.
Dmitri Alexeev is Founder and CEO of AlphaBot, a collaborative platform for alternative investment research.
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