The post-pandemic economic recovery is gaining momentum. What that means exactly in the longer term is still not clear. Nonetheless, private equity firms that have been holding onto their cash can navigate the uncertainty and deliver healthy returns if they take time to plan, says Elaine Chim, Head of Private Equity, Americas and APAC at Apex Group.
Traditionally, investors hold around two percent of their assets, or the equivalent of three to six months of cash, in reserve for emergencies. But estimates show that many investors have set aside 10 percent of their assets in the last year amid the Covid-19 slowdown. That means private equity companies around the world are sitting on a mountain of nearly $2trn in ‘dry powder'.
Coupled with interest rates that are expected to remain low, that stockpiled cash is going to spark frenetic dealmaking. A mix of thoughtful planning and operational changes are needed to enable the nimble decision-making essential to success during this tumultuous period.
That's a big shift in perspective from last year, when firms were in survival mode. Unsure of when economies would recover enough for them to deploy the cash on hand, they restructured their portfolios to avoid liquidity shortfalls. Mergers and acquisitions fell 50% in the first half of last year.
Funds that follow that formula before deploying their dry powder will find growth while others race to catch up."
There's still little consensus on how the recovery will unfold and, hopefully later, stabilize. The end of the pandemic will be unadulterated good news, of course.
But some observers fear a post-pandemic hangover that could spark a new downturn. Others are wary of government stimulus adding to inflationary pressures that would erode the value of cash. Challenges to supply chains are becoming more prominent. Labor shortages are also raising concerns about capacity. A corporate tax hike in the US could exert downward pressure on growth, too.
PE funds sitting on dry powder, however, have the perfect tool to weather this volatility. Cash gives firms the flexibility to aggressively hunt for investment opportunities while avoiding the risk of creating liquidity through untimely sell-offs that add to their tax bills.
A new crop of PE funds that emerged during the crisis, for example, are already betting that, no matter what the short term holds, the post-pandemic economy will be different than what preceded it. They're buying into fintech, edtech, medtech, the cloud and other technologies that enable remote work, learning and medicine, which they rightly expect will remain attractive options for businesses and consumers for years.
On the flip side, these firms are also finding bargains among the companies and sectors that became distressed during the pandemic. More sector-specific and forward-looking than in the pre-pandemic period, these PE funds are in a strong position to salvage them as valuations fall and government aid runs dry. These funds are leveraging the built-in advantages they enjoy over other forms of raising capital in the current environment.
IPOs might have experienced a rebound in recent months but in most cases companies today still don't want to bear the uncertainty and effort of the cumbersome follow-through requirements and compliance measures in IPOs. SPACS are increasingly popular, raising more than $75 billion in 2020, a figure almost certain to be surpassed this year. But this comes at a price. As they've become more popular, SPACS are also becoming riskier as they hastily search for companies to acquire. PE, meanwhile, avoids the hurdles associated with both routes.
While fund managers make their moves, they must ensure their internal systems and processes can adapt to the changing landscape. For PE, that means bringing in new technologies that can generate actionable insights and make funds more agile and ready to take advantage of new opportunities.
Investors' rising interest in social, environmental and governance (ESG) issues represent one of the biggest new differentiators for funds in the near future, especially with ESG-related regulatory requirements looming. The European Union recently passed legislation on sustainable finance that will have a deep impact on financial firms. American regulators are likely to follow suit.
To prepare for these requirements, PE firms should already be working to develop new criteria for their investment portfolios. Now is also the time for back, middle, and front offices to maximize the potential payoff of ESG by making sure the all the relevant teams are on the same page operating seamlessly. ESG analysis requires the C-suite to set goals, implement robust data collection, reporting and analysis tools to capture the relevant information, in a usable format, to drive change.
Achieving deal success in the post-pandemic economy requires PE to embrace planning and implementing the right internal changes that will yield the high-quality intelligence necessary to recognize and respond to the best new prospects. Funds that follow that formula before deploying their dry powder will find growth while others race to catch up.
By Elaine Chim, head of private equity, Americas and APAC at Apex Group.