Coronavirus: the views from our private assets experts
As investors assess the implications of coronavirus in stock and bond markets, we ask if private assets have lived up to expectations of more resilient valuations. By Georg Wunderlin, Global Head of Private Assets
Private asset exposure to traditional equity and bond market volatility is typically low. Indeed, the lack of correlation to publically traded investment returns is one of the compelling characteristics of private asset exposure.
However, while the long-term effects of the coronavirus (Covid-19) pandemic upon the global economy remain difficult to model, in the short-term it has become clear that the hit to global growth is likely to be severe. Private asset exposure to prolonged economic weakness cannot be discounted, and as such, it is important that investors assess the potential effects.
Below, we provide views from experts in each of Schroders' private asset businesses. As the situation develops, we will continue to update our views and reflect upon new information.
The view from Schroder Adveq on private equity
Nils Rode, Chief Investment Officer, Schroder Adveq
- Private equity is generally well positioned for surprising shocks such as created by the coronavirus. Private equity funds are well capitalised, with locked-in capital that can either be deployed for new investments when opportunities arise, or that can be used to support existing portfolio companies if and when necessary.
- The long-term investment horizon of private equity funds provides the industry with a high level of flexibility with regard to exit timing, which means that private equity managers and their investors can keep a calm mind even in turbulent times.
- For existing private equity investments, the impact varies mainly by region and industry, the specific business model of a company and its financing situation. While several private equity portfolio companies are likely to be affected negatively, at least temporarily - and some could be affected more severely - many investments are well positioned to go through this situation without any permanent impairment. A few companies might even be able to benefit from the situation (for example, companies working on potential treatments).
- For new private equity investments, the outlook additionally depends on the type of investment:
- For primary investments, the economic impact of the novel coronavirus can lead to more favourable entry valuations over time. Furthermore, primary fund investments benefit from time diversification during the typical investment period of 2-4 years.
- For secondary investments, economic and financial market turbulences can create buying opportunities. In case of extended turbulence, the current coronavirus situation could result in such buying opportunities.
- As new direct/co-investments could experience some type of short-term impact, we expect investors and fund managers to slow down their investment pace for direct/co-investments. Direct/co-investments can potentially benefit from more favourable entry valuations, but high selectivity will be paramount.
The view from Schroders on infrastructure
Charles Dupont, Head of Infrastructure Finance, Infrastructure Debt
- Investments in infrastructure are generally more resilient than other sectors, on a relative basis, for a number of reasons. Infrastructure is underpinned by essential services and demand is not expected to be as affected as in sectors exposed to discretionary spending (like retail, accommodation, leisure) or commodity prices (e.g. shale gas in the US)
- Performance is to be assessed on a long-term basis. A long-term investment in infrastructure will be less affected by short-term macro shocks than an investment with a pay back in a couple of years.
- It is not prone to global supply chain dislocation (as with industrial business, e.g. automotive companies).
- Cash flows are often backed by long-term contracts or protective regulation.
- As investors we have proactively screened our portfolios, both from a bottom up and top down perspective. We have focused on identifying infrastructure sub-sectors that are exposed indirectly to coronavirus (transportation: airports, ports, toll roads) and those that are not (renewables, regulated assets, water and waste).
- We are actively engaging with borrowers in indirectly exposed sectors to discuss mitigating measures (obvious examples would be in the airport sector).
The view from Schroders on commercial real estate – UK and Europe
Duncan Owen, Global Head of Real Estate
- The impact of Covid-19 on European economies and real estate markets is multiplying rapidly.
- Retail and leisure - In much of continental Europe shopping centres have been temporarily closed and shoppers are only allowed to visit banks, grocery stores and pharmacies. Big brands such as Adidas and Apple have also closed their stores. In the UK shopping centre footfall over the weekend of 14–15th March (prior to the shutdown) was 20–30% below normal and visits to pubs and restaurants fell by 40–50%. Some retailers and restaurants were struggling financially before Covid-19, so the number of insolvencies is likely to increase. Schroders has begun to receive requests from non-food retailers to suspend rent payments and we are working with them to find solutions.
- Grocery stores have seen a jump in sales as consumers have stock-piled goods. However, supermarkets are having to ration some goods and consumers are likely to unwind their stocks once the virus has passed.
- Offices - To date the impact on financial and business services and tech companies appears to have been relatively modest. While the legal profession will be affected by the closure of some courts, most companies have been able to maintain operations by asking staff to work remotely from home. One question is whether this temporary evacuation will prompt companies to re-think their office space requirements and whether they can be used more efficiently with agile working. This would create a flight to prime and the best flexible space in the winning cities. We believe that offices continue to be the best place for communicating with colleagues, meeting clients and promoting company culture. Covid-19 will put pressure on serviced office providers as people socially distance themselves and some operators will go out of business. London and Amsterdam have the highest exposure to serviced offices at 6–7% of total floor space.
- Industrial/logistics firms are seeing some disruption to supply chains and several big manufacturers including Airbus and Volkswagen have announced temporary shutdowns. Covid-19 has lifted demand for online retail and Amazon has announced that it is hiring an additional 100,000 people globally. In the long term it is possible that the virus, in conjunction with other pressures such as growing protectionism, encourages companies to "re-shore" some manufacturing from Asia and hold more stock in Europe. We are already hearing from the boards of logistics and manufacturing companies that they wish to de-risk their dependency on longer range suppliers and manufacturers.
- Hotels and the travel industry have been at the epicentre of the crisis. Occupancy rates in some cities have fallen close to zero. Following recent bans on non-essential travel and the closing of borders by the EU, the short-term outlook for the industry is extremely bleak and we expect temporary hotel closures and staff redundancies imminently.
- Building projects - We have not yet seen any major building projects halted, but we do expect some delays either because of materials shortages, or as workers fall ill. Those delays could raise costs and depress returns. In the short term, developers are likely to hesitate before starting new schemes.
The view from BlueOrchard on microfinance
Philipp Mueller – Head of Investment Solutions
- Most countries where our investees are located have reported very few cases of the virus to date, but it is difficult to foresee what the ultimate spread will look like. The policy response in individual countries has and will continue to differ significantly. In some countries, we have seen strong containment efforts, combined with various measures to attempt to support businesses and individuals, including fiscal stimulus and coordinated action with the financial sector.
- Our local investment teams - based in Georgia, Kenya, Peru and Singapore - are in close contact with our investees as well as with local authorities and regulators to maintain up-to-date information on this rapidly evolving situation. Our analysis focuses on the investee’s assessment of the local situation, what action plans it has put into place to address potential disruptions to its clients’ businesses and the wider local government response, both to contain the spread of the virus and mitigate impacts to the population of business interruptions that stem from such containment policies.
- It is important to highlight the role of the international development community in providing capital to the developing world. In the global financial crisis of 2008, coordinated action in the development community in inclusive finance helped significantly, providing much needed liquidity to support the ongoing operations of local institutions in the face of reduced global risk appetite. Because of this, and continued funding from commercial funders like BlueOrchard, well-performing microfinance institutions were able to continue to serve their end clients, microbusinesses and SMEs that are the backbone of these economies. Because of the resilience of such institutions and their end-clients, performance remained steady throughout the global financial crisis in 2008 and 2009.
- This is also one of the reasons why microfinance investments, particularly in emerging and frontier markets, have historically been quite resilient to shocks of this nature, particularly if you look at the global financial crisis in 2008 and (on a much lesser scale) MERS in 2012.
The view from Schroders on Securitised Credit
Michelle Russell-Dowe, Head of Securitised Credit
- Markets have gone from “sell what you can, not what you should” to just “sell”. We have seen even the most liquid markets - such as agency MBS - freeze up.
- The Federal Reserve (Fed) has now agreed to unlimited QE, or “QE infinity” as it applies to buying US Treasuries, agency mortgage backed securities (MBS) and agency commercial mortgage backed securities (CMBS). There have been multiple facilities, trillions of dollars of repo (repurchase agreements), and a new term asset-backed loan facility (TALF) for consumer ABS.
- All of this is necessary to attempt to stem the rapid declines in markets that were fundamentally stronger going into this volatility, such as mortgages and the wealthier consumer. Mortgage real estate investment trusts (REITs), in particular - due to leverage and margin calls - have created liquidation risks in the agency MBS and the non-agency MBS markets. Some of the mortgage REITs have been forced sellers, creating some eye-popping price declines across sub-sectors of mortgage land. European MBS and ABS markets are thin and offer little transparency. Collateralised loan obligations (CLOs) and CMBS are being priced conservatively given the dire statistics on the virus and the economy.
What is the market thinking:
- People will no longer shop at malls, go to movies, vacation in hotels or work in offices.
- Borrowers will not pay their mortgages or their rent
- Many businesses will fail
- The commercial real estate market will crash
- Each one of these has been in the headlines and is obviously at the most severe end of interpretation, and indicative of the concern markets are beginning to price in, given a market with a bottom that continues to fall out.
- But, in this market we have seen opportunities where it remains possible to have conviction. In high quality, strong structural protection and government support, like AAA rated prime credit card ABS issued by tier 1 banks, or in AAA rated prime auto ABS, with support from TALF in new issues, this seems a simple and safe play while uncertainty reigns. ABS, MBS, CMBS and CLO markets are diverse many ways: in borrowers, in assets and in sector exposure. As more economic information is gathered, these markets, many of which have been characterised by lower leverage and better underwriting, should offer attractive opportunities.
- The US ABS, MBS, and CMBS markets are diverse, large and fairly visible. This time around we are in a different part of the housing cycle than in 2008-2009, and with pricing & liquidity feeling just as bad, it does pave the way for opportunity when greater clarity allows for real study. Until that time, there are still ABS that remain a safer haven in our view.
The view from Schroders on Insurance Linked Securities (ILS)
Dirk Lohmann, Head of ILS
- The advantages of the Insurance Linked Securities (ILS) asset class become apparent in times like these. The risks embedded within ILS are largely uncorrelated to the economic cycle and traditional financial markets.
- In particular, event-linked instruments - driven by natural catastrophes - offer true diversification with attractive, independent yield levels and low return volatility versus more traditional asset classes.
- Life ILS - There is a small market for ILS providing protection against pandemic mortality and health related expenses. We have seen limited trading in the liquid Life ILS markets. Counterintuitively, the current market stress seems to bode well for the private life ILS pipeline because these deals typically provide capital or solvency relief to the issuer.
- The catastrophe (“cat”) bond market is typically the most vulnerable in a flight to cash environment. To date, the market has held up exceptionally well and the volume of redemptions has been limited.
- Private transactions / collateralized reinsurance have seen hardly any impairment, which we expected given their buy-and-hold nature, shorter maturities and less-frequent dealing cycles.
- For both cat bonds and private/collateralised, there has been a slight rise in secondary activity which has been smoothly absorbed. Should the volatility in the major asset classes continue for a prolonged time, some market participants might experience some more selling pressure, which will provide attractive entry levels in the long run.
- We have observed similar dynamics in the past during the GFC in 2008 as well as other corrections. It is worthwhile to keep in mind that such corrections would be purely a market-driven effect and not due to the losses of the underlying insurance risks.
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