The world has changed drastically over the past two weeks in all respects. Central Treasuries across the globe are implementing policies that a month ago were unthinkable, equities markets have seen historic drops while, at the same time, yield spreads have been widening.

The alternative asset class will not be immune to the effects of Covid-19. We have tried to outline below what we are experiencing first-hand and what we have been hearing anecdotally in the market.

Risk management comes to the fore for Managers and their Funds

Such seismic market shifts have led to significant reprioritisation across the board. Risk management has come to the fore for managers. Our hedging teams have seen a c.20% uptick in new hedging transactions as GPs aim to better manage market volatility, free-up liquidity and move trades over from less creditworthy counterparties.

Furthermore, the cut in interest rates and the impacts on FX rates have led to many managers enquiring about management-fee hedging and solutions that don’t require posting of collateral.

Defending the portfolio is now the number one goal

Almost all managers have shifted their focus from deploying capital to defending assets. This has led to a significant increase in calls to the Fund Solutions desk to discuss NAV secured fund facilities as managers explore alternative forms of liquidity to prop up companies, prevent breaches and reduce the possibility of having to call any remaining capital from LPs.

New acquisitions and M&A activity appears to be on ice, with some advisers in both the primary and secondaries space reporting that 90% of their M&A mandates being put on hold.

There is general acknowledgement that the corporate debt market is tightening, resulting in GPs having to look at more creative ways of financing new deals. Not only this but given the significant impact on many industries managers may be forced to evaluate and adjust their investment strategy. While it may appear that deals are still being completed and announced this is a trailing indicator of market activity as many of these deals have been in execution for quite some time.

There is general acknowledgement that the corporate debt market is tightening, resulting in GPs having to look at more creative ways of financing new deals.

However, a few market participants have been waiting for a price correction. Defendable assets are well placed to take advantage of cheap bolt-ons and growth. Managers that haven’t deployed aggressively and have significant dry powder expect to find value in transactions in the near to medium-term once the dust has settled.

Secondary funds are also keenly eyeing opportunities for either traditional secondaries at high discounts, or more creative pref structures.

Secondary advisers and buyers are pivoting towards deals with downside protections such as pref equity or NAV credit-like structures. Before last week, we had also heard of fund of funds enquiring if there were opportunities to increase their stake by buying out other LPs.

Valuations in a time of volatility:
A key question for all players in the space surrounds valuations. Given the upheaval of the public markets and the possibility of losing at least 25% of production for most industries, it is expected that there will be significant write-downs across the board.

A well-known manager has indicated that a 20% – 50% write-down is possible. Our conversations over the past week have confirmed this, with most Fund of Funds that we have spoken to expecting an aggregate of a 30% decrease in value.

Many GPs are beginning to run scenarios and valuations for March numbers. However, at this stage GPs are warning LPs that any attempt to currently value assets are most likely to move in the weeks ahead, leading to possible delays in Q1 fund reports and even December reports given the challenges of widespread working from home. It is also expected that we will see drops in value for both March and June numbers.

Ensuring there’s enough funding optionality:

Managers are evaluating their portfolios as expected and identifying any potential gaps, with weekly calls to portfolio companies becoming common. We have seen strong evidence of robust analysis and scenario-planning from our clients.

GPs appear to be managing their liquidity options in various ways – either paying down facilities early to ensure that there is headroom and availability when it may be needed further down the line or fully drawing down on committed facilities now, to ensure that cash is available. There have been rumours in the market of some funds calling on capital to sit on cash. However, we have not been able to verify this.

Conversations with some of the secondary houses and Fund of Funds have also revealed a mixed bag, with some seeing a marginal increase in capital calls and others seeing them in line with expectations, although for how long this will remain the case is uncertain.

All of our clients have been actively engaging with their LPs. To date no LP has reported any challenges in their ability to uphold a capital call. However, LPs seem to be happy for funds to fully draw on their subscription facilities. Cadwalader has also reaffirmed that it does not believe that there will be any delinquencies, but note that upcoming calls will be the first test of liquidity since the GFC.

Liquidity remains generally robust, but caution is the watchword:

Our own sales team has reached out to multiple banks and institutional investors to understand their view on the market and the current situation. In general, all banks appear to remain open for business and have sufficient liquidity.

Conversations with our panel law firms have revealed that almost all conversion of uncommitted to committed facilities has been successful and that no lending transactions have yet been pulled from execution.

Most banks that we have spoken to have indicated that they are being more selective of new business, with a big focus on existing relationships. The only clear sign we have seen so far of a lender pulling back from the market has been a well-known fund finance bank refusing to roll over an existing subscription facility for a reputable fund manager.

Chances of a NAV deal?

NAV deals provide a liquidity option and an alternative to preferred equity. As mentioned above, banks are being more selective of the deals that they are doing and given the uncertainty around valuations, LTV and pricing, manager and asset quality will be even more key going forward.

These deals will take significant experience to implement successfully, taking into account the situation, structure required and both GP and LP preferences. In-depth discussions around valuation going forward and normalised expectations of performance can be expected. Underlying debt will be considered and any assets that are near breaches will need to be thoroughly evaluated to be excluded from the borrowing base.

Hybrid subline/NAV structures are also being considered as GPs use all tools in their arsenal to achieve the right balance between facility flexibility & price.

The next few months will be defining for the industry. It will be the first true test of PE and fund finance for more than 10 years. Not only this, but the PE world is very different today to where it was then, with more than $10trn of assets under management¹ in global alternatives and a much larger allocation to the asset class.

Defending value and ensuring there is sufficient liquidity will be the name of the game over the coming months as Managers, LPs and providers all work to recover as quickly as possible.