Given the scale of the COVID-19 outbreak, lockdowns across major countries, and its consequential effect on global economy, alternative investment managers need to rethink their allocation strategy.
Impact of COVID-19 has started showing its early signs – hedge funds valuation were down by 8.89% in March 2020 against February (compare this with 8.1% drop in October 2008 against its previous month during global financial crisis).1
A clearer impact on performance of other asset classes is likely to be evident by the end of Apr-Jun (2020) quarter. In addition to battling prevailing challenges of the industry in terms of regulations and operational efficiency, investors should be wary of further COVID-19 setbacks and also gear up for possible opportunities that will be presented by the new normal post the lockdown (See Figure 1).
Figure 1: Possible COVID-19 impact across alternative asset classes
COVID-19 impact: The challenges and opportunities
Private equity firms are holding estimated dry powder worth USD 1.5 trillion which can be utilized to hunt and invest in companies affected by the COVID-19 outbreak (retail, hospitality, tourism and transportation) that are available at attractive valuations. For example, private equity firms already invested in couple of companies in specific industry can acquire their competitors and plan for a merger of these companies to gain market share and build value for long term. Firms with lower leverage in their investments may be in a better position to deploy the dry powder, buying distressed assets at low valuation and pursuing merger opportunities for portfolio companies. The pursuit of new investments will need to be preceded by investing in existing portfolio companies to support their affected operations due to liquidity crunch. Since private equity industry is insulated from sudden redemption requirements, firms can take futuristic view and wait before exiting the investment.
For hedge funds, opportunities lie in acquiring distressed assets at very low valuations. It is recommended to hold these assets in short term and then benefitting by exiting the investment in medium to short term. The impact of COVID-19 will be extensive for most of the countries and hence devising a country or region specific investment strategy leveraging interest rates and foreign exchange fluctuations would be beneficial for hedge funds. Hedge funds with shrewd ability to discern the winners and losers in this crisis will certainly generate much higher returns. Amidst this outbreak, there are several companies that will perform and show good earnings, hedge funds managers need to spot these opportunities and invest at compelling valuations.
Due to unprecedented impact of COVID-19 on how people will live and work in future, real estate industry will face challenge in attracting funds from institutional investors. Apart from the short-term impact in terms of construction delays and stoppage of cash flows, real estate industry will be hit hard with a long lasting effect. Players will have to think through a new business model considering people might consider distancing socially for long time even after the end of the crisis. Work from home may become the new normal affecting investments in office infrastructure including the co-working model, which was already imploding after the disastrous IPO experience of WeWork.
The impact on Private Debt is still not evident while stimulus packages like infusion of USD 2 trillion in US economywill considerably increase liquidity and access to loans, lenders on the other hand, will become more risk-averse, limiting credit extension. The sector was already reeling under pressure before COVID-19 due to intense competition damaging returns. There is huge amount of capital raised but there is dearth of good deals where this capital can be deployed. Other concerns include poor liquidity along with freezing of high yield debt instruments in many markets.
Other alternative investments like Infrastructure will be impacted as nations across the worlds will not be looking to build roads, ports and other core infrastructure immediately. Work-in-progress projects will be significantly impacted due to lack of funds and uncertainty of demand. With nations sealing their borders, the supply of critical project equipment and material will be impacted. On the flip side, governments around the world would be more focused on improving healthcare facilities by building more laboratories and hospitals. Most governments would have the onus of improving employment rate, which might in fact, lead to certain infrastructure spending as the situation normalizes.
Before the COVID-19 outbreak, this sector has seen record fundraising and investors’ interest for better returns. Given the current situation, the players have to reduce their expected target returns. Also, there has been continued attraction towards Energy and Renewables due to global focus and regulatory requirement towards decarbonization.
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