The COVID-19 pandemic remains the key risk to US private markets, industry experts say
The COVID-19 pandemic remains the key risk to US private markets, industry experts say
The US presidential election has now taken place, and with the potential for a COVID-19 vaccine on the horizon, alternatives industry professionals will be hoping for a clearer path forward. We asked experts across private equity, venture capital, and private debt to share their outlook on the next 12 months, what the election results might mean, and where the risks and opportunities lie.
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Christopher J. Wolfe, Chief Investment Officer at First Republic Private Wealth Management
We expect a divided Congress, and the focus is likely to shift toward a President governing via executive orders. We would also expect issues around trade, immigration, and domestic policy to be the focus. In the near term, we see stimulus in the first quarter of 2021, and that will be the driver for markets – put simply, stimulus and the expectations for more is overwhelming all other market metrics for the time being. Our view is economic growth may not change much with a vaccine in the next two quarters, but a vaccine could likely reset the trajectory around a broad reopening of the economy that will be much quicker in the latter half of 2021. However, we believe the focus will need to be on deployment and adoption in order to see sustainable success.
On the private markets side, we have been in a period of flight to quality in favor of relatively larger deals and more established fund managers. We expect merger and acquisition volume to improve across broader sections of the economy as election and COVID-19 concerns subside in early 2021 and we factor in some level of government support. We believe investors will assume a measured growth and valuation trajectory for deals, but remain willing to pay up for sectors gaining from structural changes due to the COVID-19 economy such as internet, digital health, and e-commerce.
Both private equity and private debt remain highly competitive sectors. Returns will be driven by a few things:
- Creativity in sourcing niche opportunities
- A disciplined process in terms of price and leverage
- Strong risk management
- Flexible business models
- Management teams with experience in navigating economic and policy uncertainty
COVID-19 has accelerated secular trends in technology; we believe technology-driven growth strategies will continue to be disruptive and drive new business models and productivity across all sectors.
The ability to price and close deals will be challenged by a competitive environment and weak visibility into economic conditions. Additionally, the search for yield and cheap leverage will encourage undue risk taking. With these risks in mind, managers need to remain disciplined; deviations from process are growing more critical as risks in an uncertain environment.
LPs need to stay focused on their core value propositions and enhance them with technology. Our focus is on managers with a proven ability to navigate volatile markets and periodic policy-driven dislocations. Additionally, recent trends highlight that environmental, social, and governance (ESG) factors are increasingly a primary area of focus for LPs and GPs.
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David Lebovitz, Global Market Strategist at J.P. Morgan Asset Management
It's been interesting to watch volatility decline in the aftermath of the election. There was clearly an expectation that a Blue Wave was coming, and people were positioned for a reflation trade driven by significant fiscal stimulus. Then we ended up with what we believe will be a divided government, and while we're still waiting, it seems that has removed a significant amount of uncertainty, as evidenced by the decline in volatility.
A look at where the VIX is today [around 25.4 on November 12] makes me a little bit uncomfortable. Yes, the election was a big deal, but it's not the only thing that we need to be conscious of heading into 2021. While one source of uncertainty has been removed, the COVID-19 pandemic remains. Despite the good news earlier about a vaccine, investors may be getting a little bit ahead of themselves. Additionally, there are still a lot of questions around the growth outlook and what policy is going to look like. How does policy evolve outside of the fiscal stimulus realm with such a narrow division in the government?
Regarding a change in capital gains tax: I don't think the new administration is going to get anything done on that; I think that conversation got put to bed. The executive branch does have some power when it comes to regulation, particularly with respect to energy and the EPA [US Environmental Protection Agency]. So, I think the road has been cleared there to an extent, but I don't think taxes are headed higher in the short term, assuming a divided government outcome.
The conversation, as it pertains to private equity investors, depends on where you are in the lifecycle of the fund. For those funds coming due in the next few years, we don't think taxes are headed higher for the reasons stated above; but in the longer term, taxes are going to have to go up. Historically the government has brought down debt-to-GDP through better nominal growth and higher taxes.
The tax lever will probably get pulled at some point in the next 3-5 years, and capital gains taxes may be the price of admission. Clients would love to keep 70 cents on every dollar rather than 50, but the way the rules are written shouldn't impact whether or not you invest in private equity. We have to play the hand that we're dealt.
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Randy Schwimmer, Head of Origination and Capital Markets at Churchill Asset Management, the private capital affiliate of Nuveen
The election isn't going to have an immediate impact because the assimilation of the results and the incoming of the new administration are still weeks away. The fundamental factor that will affect the behavior of both public and private markets is the path of the virus.
COVID-19 takes precedence over what's happening politically; you’ve seen what happened in the public equity markets with regard to the potential for a vaccine. That, more than election results, is driving significant optimism in valuations – which will ebb and flow depending on the reality of the work that must be done.
One election-related event which fascinated me was how the M&A market caught fire in the middle of the summer. I call it the ‘Big Bang’ because founders, entrepreneurs, middle-market companies – and some larger companies too – saw the potential for a change of administration. That opened the possibility for higher capital gains taxes next year. If you are the owner of a company and you could put $100mn in your pocket, by selling now you made the bet you would get more in your pocket than next year.
Another factor is that we will likely find ourselves with a divided government, which historically has been salutary for markets. Worries about a Blue Wave and a more progressive agenda have faded, calming down the business world.
Business owners and managers more than anything look for consistency and predictability from government leaders and policies. Give them rules and guidelines they can count on, and they can adapt to almost anything. It's the constant flip-flopping that’s the most challenging.
Right now what markets are hoping for, after an extremely volatile and trying year, is some calmness.