It would be hard to overstate the devastation that the coronavirus has wrought around the world. But although the effects of the pandemic undoubtedly qualify as a crisis, is it the kind of crisis that has seriously tested the fundamentals of the private debt asset class?
Opinion at our Private Debt Investor Debt Week was that it still may not provide limited partners with the anticipated opportunity to determine the best (and worst) performers in bad times, as well as good.
“The next crisis may be very different in nature”
In the view of David Ross, managing director at Toronto-based fund manager Northleaf Capital Partners and a Debt Week panellist, covid-19 has been a kind of fire drill.
“No one was expecting it and everyone got out of the building quick,” he said. “But it was soon determined that while it had tested systems and procedures, it had not significantly impaired portfolios.”
Although covid did not shake the industry to its foundations, there were still useful lessons.
Perhaps the most useful one, according to Ross, was the importance of liquidity. As cashflows dried up, fund managers and investors were forced to face the reality that a lack of capital could lead to impairment – especially in the non-sponsored space, where the widely noted willingness of private equity firms to dig deep into their pockets was not an option.
There is a view that some GPs have maximised leverage and taken whatever means necessary to drive up the eventual returns without necessarily setting aside any funds for a rainy day.
This brings into question whether managers, even if they were willing to do so, would have the flexibility within their fund structures to inject liquidity seamlessly and swiftly into portfolio companies should the need arise.
Of course, in many cases it was not just private equity sponsors stepping up to help firms through the tough times, but also governments. This was, however, a crisis during which governments felt compelled to nurse workforces through what were perceived to be temporary difficulties.
The next crisis may be very different in nature, and it would be wrong to assume that the same kind of safety net will always be there. Covid may only have been a drill, but at some future date the building might actually be burning.