Why Previous Crises May Not Be a Guide to European Buyout Fund Performance Post-COVID-19

Given the unprecedented nature of the pandemic, its impact, and the response, 2020 and 2021 may follow a different path

As a second wave of COVID-19 gathers momentum across Europe, fears of another substantial economic hit are rising as recovery packages in many countries draw to an end. But with buyout fundraising in the region stronger than many expected, investors appear positive about future returns in expectation of pricing adjustments. If this optimism is grounded in the performance of past crisis-era vintages, to what extent is it justified? To find out, we looked at data from Preqin Pro to see what crisis-era returns can tell us about the potential impact of COVID-19 on Europe-focused buyout performance.

Past Crises at a Glance 
It wasn’t until 2009 that the full impact of the Global Financial Crisis (GFC) hit the European buyout market – in fundraising terms at least. Europe-focused buyout funds had experienced several years of solid demand from investors, with fundraising between 2005 and 2008 averaging $74bn. But this was the final phase of the post-dot-com recovery, with Lehman Brothers failing in September 2008. 

In the following year, fundraising dropped off a cliff. Just $37bn was raised throughout 2009, down 58% compared to the $88bn secured in 2008. Totals were worse still in 2010, dropping by a further 53% to $18bn, representing a cumulative decline of 80% in two years. 

The 2007 vintage marked the nadir, with a median net IRR of 8.2%. This could be due to the combined effects of late-cycle valuations early in 2007, followed by sharp adjustments to pricing as the financial crisis emerged later in the year. Performance quickly recovered in 2008 and beyond, with government and central bank stimulus packages leading to a rise in asset prices after the period of repricing. The period of reduced capital inflows before 2013 might also have helped to reduce competition for those in market as the crisis unfolded. For funds of vintages 2006-2010, there was less dispersion among returns compared with the 2005-2017 longer-term average. 

It would take the European debt crisis to hit before median net IRRs declined again. 2012 marked a minor blip: median net returns were still 15.8%, above the 2005-2011 average of 12.6%. There was an immediate recovery and median net IRRs hit 17.0% and 22.2% for 2013 and 2014 vintages, respectively. The following three vintages (2015-2017) averaged a median net IRR of 14.6% as returning confidence pushed up prices.

The trends witnessed throughout these periods tell us several things. Importantly, returns can adjust faster than investors. In addition, the amount raised is less important than the stage of the cycle at which funds are deployed. It’s this point that is key to understanding the potential impact of COVID-19 upon Europe-focused buyout funds. 

A Question of Timing
As the cycle extended, returns had fallen from the 2014 peak back down to the longer-term average (14.4% for vintages 2005-2017). That said, at well into double digits they remained attractive as government bond yields turned negative. At this point, investors were worried that frothy pricing had crept in after years of loose monetary policy and resurgent confidence, according to Preqin’s investor survey. 

Despite these concerns – possibly buoyed by the strong returns relative to other asset classes – Europe-focused buyout funds still attracted significant amounts of capital. Fundraising hit at least $65bn each year between 2016 and the period up to the end of August 2020. It’s likely that as 2018 and 2019 vintages declare their returns, we could see them flatline, rather than accelerate, owing to the late-cycle effects. 

What about 2020 and 2021? Investors have reacted immediately to the current circumstances, with fundraising strong and not far behind 2019 levels (see chart), with more than one quarter of the year still to go. It’s likely the economic hit has made investors more positive, at least where potential returns are concerned, as they expect valuations to adjust and returns on positions taken in the near term to accelerate. This confidence may be misplaced. 

It remains to be seen whether we are in the final throes of the post-GFC cycle, or the early stages of the post-COVID-19 adjustment cycle. Government and central bank intervention in 2020 is vastly different to that experienced in the GFC. Fiscal policies have come to the fore in ways we could not have imagined at the start of the year. Furlough and job retention schemes, tax holidays, and generous handouts are all serving to aid economic recoveries post-lockdown. Central bank asset purchases are also taking place on an unprecedented scale. When this stimulus begins to roll off, there may be a second wave hit to economic activity from the need to balance the books and find sustainable fiscal positions – regardless of the second wave of COVID-19 that looks set for the European winter. 

As a result of the unprecedented intervention, ultimate transaction activity may decline but valuations may not fall as fast or as far as previous crises during 2020. It may be that 2021 is the year returns across the European buyout space hit their nadir – a full 14 years since 2007’s low point – and the recovery cycle begins in earnest – if past crises are anything to go by. 

For more insights and analysis on the impact of the pandemic on alternative assets, take a look at our COVID-19 Knowledge Hub.