Finding a Good Buyout Fund Was Seemingly Easy. Then Covid-19 Arrived.

The buyout industry is facing a shakeout in the Covid-19 downturn, as cracks in performance emerge for institutional investors who had been benefiting from seemingly low risk in fund selection. 

Strong private equity performance in 2019 marked the “calm before the storm,” with leveraged buyout funds achieving valuations of about 1.45 times their investments and exceeding the ten-year average of 1.36 times, according to an eFront report Tuesday. The firm’s data show that fund-selection risk last year was at one of the lowest levels in the past decade.

Now investors in private equity funds are studying the damage done to their portfolios during the first quarter, when the bull market ended abruptly amid fears tied to Covid-19. 

“Funds that have been heavily investing in the pre-downturn period, particularly vintage years 2016-2018, will experience the most substantial adverse effects on their performance,” eFront, a provider of alternative investment data and analysis, said in a statement on the report. 

Blackstone Group, Apollo Global Management, Carlyle Group, and KKR & Co. have each said that the value of their private equity portfolios dropped in the first quarter. Like the performance data provided by eFront, their fund valuations included both realized and unrealized investments in companies, meaning investors could see higher returns once the funds fully exit their deals.

[II Deep Dive: Carlyle’s Private Equity Funds Fall as Investors Weigh Portfolio Damage]

Exiting investments will likely take longer because of Covid-19, the disease caused by the new coronavirus that has prompted businesses to shutdown globally to slow its deadly spread. “LBO funds will delay selling assets in the face of a challenging exit environment,” eFront predicted.

Before Covid-19, private equity firms were benefiting from a “robust” environment for sales and debt-fueled dividends, “keeping the average time-to-liquidity at a historically low level,” the firm said. “The average time-to-liquidity of LBO funds has remained stable and at a rather low level throughout 2019, albeit rising slightly to 2.73 years in the final quarter.”

eFront will assess the early effects of the Covid-19 downturn on fund-selection risk once it has data on private equity performance for the first half of 2019. Fund-selection risk is measured by the dispersion in performance between the top and bottom five percent of fund managers. 

Since 2016, the performance dispersion had declined “substantially,” remaining flat last year, according to eFront. That’s likely to change based on its analysis of the last downturn, revealing investors’ winning and losing bets in private equity.

During the 2008 financial crisis, the bottom 5 percent of funds “suffered a more significant loss” in their net asset values than the top performers, the firm said. While the Covid-19 “shock” may not be “symmetric,” eFront said “it is reasonable to expect that the selection risk measure will increase.”