Partners Group is a leading global private markets investment manager with over USD 109 billion in assets under management and more than 1500 professionals across 20 offices worldwide.
Private Markets Outlook 2021
In our 2021 Private Markets Navigator, we share our economic outlook and investment preferences for all private market asset classes. We explain how we are navigating our portfolio through the challenging macroeconomic environment and outline the transformative trends that we believe will deliver the best opportunities for transformational investing on behalf of our clients.
Private equity: transformational investing
Triggered by the COVID-19 outbreak and the closing of the economy, private equity activity entered a "risk off" mode between the end of February and May 2020. Sales processes were delayed and global buyout volumes in Q2 2020 plunged by 40% year-on-year. The gap in valuations between what buyers were willing to pay and what sellers expected weighed on activity, on top of the physical distance challenges faced when conducting due diligence and closing transactions during lockdown.
Debt markets have since reopened and capital markets have rebounded. However, investment volumes and valuation levels remain bifurcated across sectors. Resilient, high-margin assets with growth visibility are in high demand and, consequently, trade at premium valuations, often exceeding pre-COVID-19 levels.
The nature of investment opportunities that we are pursuing in a post-COVID-19 environment has not changed but sharpened. We continue to look for resilient, high cash-flowing assets with above-average profit margins and growth potential driven by secular trends.
This is especially the case for companies that have embraced or are facilitating the transition toward a digitized economy and certain segments within the healthcare sector, with IT software and essential health services being prime examples. At the other end of the spectrum, multiples and investment activity in industries that were severely impacted by the pandemic remain subdued, including client-facing business models reliant on high customer volumes, such as airlines and hospitality. Similarly, highly levered, cyclical businesses require a return premium to compensate for increased uncertainty. We expect this dispersion to continue.
Dynamics within a single sector can vary greatly as has been clearly demonstrated by recent events, depending on whether the business offering of an individual company is client-facing versus remote, digital versus traditional, or bespoke versus off-the-shelf. High-level sector categorizations such as "healthcare" or "consumer" have lost some relevance as a result.
As we look at opportunities, we are focusing on the visibility of organic growth, consolidation potential and downside protection. In this context, we may accept higher prices if we have a strong conviction about future growth resilience.
Private real estate: opportunity in adversity
The immediate effect of COVID-19 on the global commercial real estate sector was a sharp decline in transaction activity: deal volumes fell by 55% in Q2 2020 compared to the same period last year. This decline was partly caused by an inability to perform due diligence while lockdown measures were in place and wide bid/ask spreads that encouraged sellers to hold assets for longer.
We expect an increase in activity in 2021 as potential negative year-end valuation adjustments get absorbed and sellers adjust their price expectations. In certain instances, however, we anticipate there could be deeper distress felt by both GPs and LPs, particularly those exposed to retail, hospitality and troubled office assets, with a fall in valuations and capital constraints leading to distressed sales activity.
There is a clear divergence in performance across various real estate segments. Logistics has been the relative winner. Strong growth in e-commerce has driven the demand for last-mile logistics, supporting rental levels. Office has been challenged as physical occupancy dropped significantly due to the crisis. In the residential sector, meanwhile, people continue to migrate to places where they have more space and can find relative affordability. Retail has also been hit hard as store front rental receipts fell materially during lockdown periods, exacerbating a sector decline that was already well established. Equally, for hospitality, lockdowns have caused hotel revenue streams to tumble.
Given today’s market environment, we take a very cautious outlook on rent growth in the short to medium term and maintain prudence in our underwriting assumptions, shying away from opportunities that do not meet our strict standards. As valuations adjust and bid/ask spreads narrow, we expect to see a material increase in opportunities in 2021.
For office and residential assets, it is too early to assess how remote and flexible working will impact long-term demand in metropolitan areas such as New York City, San Francisco and London. Nonetheless, we have conviction that growth cities, characterized by above-average population and employment growth, will continue to attract companies and people, driven by their lower cost base and favorable tax regimes relative to high-cost gateway cities.
The logistics sector continues to benefit from the growth of e-commerce, which has been accelerated by COVID-19. Retail and hospitality continue to be clear underweights. We expect the shift from bricks-and-mortar retail to e-commerce to continue to challenge the retail sector until rents stabilize at affordable levels and more leases convert to turnover-based structures. We also remain cautious of pursuing heavy asset repositioning opportunities in these sectors unless they are justified by high discounts, which we are generally not observing in the market at this time.
Private debt: lending with an ownership mentality
The COVID-19 sell-off represented the sharpest market correction in history, and the impact reverberated through the debt markets as much as it did the equity markets. The role of rating agencies as the pandemic gripped the world was instrumental to the flow of debt capital. The rating agencies, disparaged during the GFC for their slow response to a changing market, were much faster this time. Rating downgrades have more than doubled during the last twelve months, leading to a growing single-B universe in leveraged loans. Loans for large-cap corporations that would have traditionally sought financing in the primary market struggled to syndicate and often found solutions in the private debt market, albeit at lower volumes, due to speed and certainty.
This trend created opportunities for us, as we were equipped to understand the nuances around ratings and the relative value that comes from offering private financing solutions to strong businesses. While the flow of capital around financial markets will continue to be disjointed in an environment coming to terms with COVID-19, rebounding private equity investment volumes strengthen our belief that we will continue to see demand for private debt.
The private direct debt market has grown to USD 848 billion and will be an integral source of financing for middle and upper mid-market companies as other sources of financing decline due to withdrawals, redemptions and a potential rise in the number of non-performing loans.
When we look at the current market, we see relative value in large and mid-cap direct senior secured loans, especially "club-style" financings, where the limited number of lenders in a debt tranche increases negotiation power. We focus on category leaders in non-cyclical, COVID-19 resilient, established businesses with stable cash flows and attractive profitability and provide them with new or incremental financing.
Despite some rebound in credit metrics, which followed the significant financial support infused into financial markets, we still see investment opportunities with better credit documentation and lower absolute leverage than we did prior to the outbreak. Leverage levels for US buyout transactions have decreased to 5.4x compared to 5.8 to 6.0x in previous years, while equity cushions in the US and Europe have increased to around 50% .
Liquid loans
During the COVID-19 induced market sell-off in March 2020, collateralized loan obligation (CLO) issuance and primary loan issuance all but shut down due to the market’s inability to price assets. The loan market, which pre-COVID-19 was prone to downgrades and increasingly dominated by B and B- rated companies, suffered aggressive rating agency downgrades as they sought to avoid criticism for being slow to act, which they received during the GFC.
The large single B and increasing CCC universe will likely persist for some time, and will likely pressure existing CLOs, forcing them to reject lower single B rated risk and making banks reluctant to underwrite such risk. We expect this market gap to be increasingly filled by private debt providers who can provide execution certainty in return for better economics and structures.
Infrastructure: the platform-building opportunity
Resistant to the most punitive effects of the COVID-19 pandemic, the fundamentals for infrastructure assets in our investment universe remain broadly unchanged. Close to USD 70 trillion of infrastructure investment will be needed over the next 15 years to support growth . What is more, infrastructure is crucial for crisis recovery.
It is likely that over the coming months the global policy response will move away from short-term support measures toward long-term, productivity-enhancing infrastructure investment. The pandemic may alter infrastructure policies, such as deprioritizing mass transit and placing greater emphasis on the densification of digital infrastructure, but, overall, infrastructure spending will prove critical to international recovery plans. Sustainability is also likely to become a more dominant theme.
Valuations have eased off their pre-COVID-19 peaks in many industries. Assets with cash flows tied to GDP (e.g. airports), assets sensitive to commodities pricing (e.g. oil price-exposed midstream assets), and “infrastructure lite” assets (e.g. services assets) have been hit hard. Meanwhile, across sectors, assets with fragile capital structures that were over-levered or very cash tight also experienced valuation contractions (e.g. oil & gas upstream assets). This adverse impact was only partially offset by expectations of prolonged low interest rates. A notable exception is digital infrastructure, where valuations have remained elevated thanks to the resiliency of the sector and strong tailwinds in digital penetration.
In terms of sectors, we maintain our focus on above-average growth segments that benefit from transformative trends, such as clean energy and digitization.
Within target sectors, we seek out assets with true infrastructure characteristics: hard assets and strong businesses with long-term contracted cash flows and high barriers to entry. We expect that valuations for these quality assets will likely continue to be elevated and we therefore remain committed to no “cheap buys”, even in a post-COVID-19 world.
One structural trend that underpins our approach to the market, is the ongoing densification of digital infrastructure. COVID-19 has sharpened the focus on the utility-like characteristics of digital infrastructure, and network densification and upgrades are key to meeting fast-growing data consumption globally. We look at infrastructure for better coverage, faster speed, and for the management and storage of data. The former includes assets such as macro towers, distributed antenna systems (DAS), small cells, and transport/backhaul fiber capacity. The latter focuses on data centers.
The sector has traded well throughout the COVID-19 crisis. Mature data center platforms have seen average EV/EBITDA multiples of approximately 20 times in recent transactions. This is reflective of the stickiness and low credit risk of customers and the embedded development optionality. Considering the elevated valuations for operational assets, we mostly look at building core and/or development data center opportunities in the Asia-Pacific region, where the availability of such projects is higher than in mature markets.
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