An update from manager Alan Gauld
In this podcast, manager Alan Gauld discusses the impact COVID-19 has had on private equity, how portfolio companies are reacting to the crisis and how the Trust is preparing for the future.
Recorded on 4 June 2020
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Interviewer: Welcome to the Aberdeen Standard Investment Trusts podcast series where our investment trust managers discuss how they're responding to the COVID-19 outbreak. Today we welcome Alan Gauld, Manager of the Standard Life Private Equity Trust. Hi, Alan. Clearly, it will take some time for revaluations in private equity to work through the system. But I'm wondering what early signs you're seeing in terms of the impact of the outbreak on private equity?
Alan Gauld: I think it seems clear that private equity valuations will decline in March, by how much is difficult to say at this point as I speak. But in Q1 public stocks dropped 20%, 30% or more, depending on the sub sector and private equity firms use relevant listed companies as values and comparators for their unquoted companies, and so there will be some impact. The earnings of private equity European companies anyway are not likely to been especially impacted in Q1 other than perhaps the second half of March. It should have held up reasonably well. But yes, we do expect there to be a COVID-19 as the March accounts come in. I mean, private equity valuations are for the most part quarterly. So more generally, it is difficult to say how things will progress as the year does, but the June mark will certainly be difficult to say. Public markets have bounced significantly since March. Which seemed somewhat illogical, but they have and if that continues to be the case until the end of the month, then obviously that will have a positive impact. Equally, earnings will have been impacted by lockdowns across developed western economies in Q2. So it’s difficult to say more longer term, but I think, we can say with some certainty that March numbers will be down and materially so. That said, private equity is not especially well correlated with public indices. Private equity firms tend to put in some buffer on the way up and on the way down, they tend to discount their companies on the way up, and that does dampen some of the volatility relative to public markets. More broadly, we're seeing new mergers and acquisitions have significantly dropped and it’s very difficult to start new sales processes, to buy businesses without face to face interaction. It’s possible that some deals that were already in train just prior to COVID could be resurrected, but we expect 2020 to be significantly down in terms of new deals and private equity exits. I think at the moment just to conclude I think private equity firms are focused on supporting their existing portfolio companies right now. We can come on to that in a little bit more detail a bit later on, but that’s certainly where they can most focused in the last couple of months.
Interviewer: Presumably, you've been talking to your sort of underlying holdings through this process, and what kind of feedback are you getting from them - what's the mood music there?
Alan Gauld: Well, I think we see the private equity firms generally reacting pretty well to the crisis. You know, we're coming off with one of the longest bull markets in history, if not the longest. So these firms have been expecting something to happen, perhaps not a global pandemic, but they've been expecting a crisis of some sort and so they've been building more recession resilient portfolios in recent times. All of the managers that we back and have funds with Standard Life Private Equity Trust are managers we've known for over 10 years and weathered the global financial crisis which wasn't that long ago. I think how they’ve reacted - the first thing has been to look after their people, so people within the private equity firm itself, but also in their portfolio companies. And then they've moved really quickly to shore up liquidity in the underlying portfolio companies and to cut costs there. Certainly businesses have been effectively mothballed depending on sector, particularly travel dependent companies. They've been really good actually at communicating with investors such as ourselves and provided really detailed reporting. It's been impressive actually. So, so far so good in terms of their reactions to what is a very difficult situation. In terms of portfolio companies themselves, I don't think it's as simple as like black and white and haves and have-nots. It's a very broad spectrum in terms of impact of COVID-19 across our underlying book. You see sectors like for example software, just slightly to a lesser degree healthcare and consumer staples proving to be resilient so far. And in some cases actually have a positive impact on the back of COVID. For example, we have a business called TeamViewer in our portfolio, which is backed by a private equity sponsor called Permira. And they listed the business in Frankfurt in 2019 actually, and that business does remote desktop software. So it’s seen record sales as so many people are working from home. On the flipside, you see sectors like consumer discretionary, and we have a number of bricks and mortar retailers and travel businesses as well and they're not doing anywhere near as well for obvious reasons. That said, we've got a business called Action which is backed by 3i, which is a discount retailer in Continental Europe. And it has managed to keep all its stores open during the crisis, and it's traded well given the circumstances. Ultimately, I think this is all part of it. It's important to be diversified and within the Standard Life Private Equity Trust we have over 400 companies and pretty balanced diversification by sector and country.
Interviewer: And have you made any adjustments to the portfolio during this period? I mean, I recognize private equity isn't always liquid enough to sort of make radical changes, but at the margins have you backed away from certain areas or taking new investments in certain areas?
Alan Gauld: Not especially, not so far. For us, private equity is about long term investing, and as I said before, I think that we've been anticipating a recession or crisis of some sort for some time and so have the private equity managers that we back. Really, we will continue to back managers that we know well, that we know them for a long period of time, and at the moment all managers that we back we have known for over 10 years. All of them have had experience of the global financial crisis, and all of them bring strong operational value add to their underlying companies. That's the type of manager we'll just continue to back. In preparation for this period of more difficult situation, we introduced the co-investment strategy in 2019, and we have been cautious about deploying that. So far we've only deployed into two businesses, and whilst they're admittedly consumer focused, they are more resilient consumer staple in nature. So Action, which we've mentioned already, and Mademoiselle Desserts is the leading European frozen bakery business, which is selling frozen dough and products into supermarkets. And so with stockpiling that's managed to show resilience through COVID-19 as well thus far. We could have done more in co-investment, but we didn't want to be aggressive in what we saw was a market which was reaching its peak. And other ways that we have been preparing for this in advance have been things like conducting a secondary sale of assets in 2019, assets that were deemed non-core, where we saw limited upside, which light us to free up cash and free up commitment and simplify our portfolio frankly.
In addition as well, we feel our balance sheet is in a pretty good position right now. We have held back cash in recent times. We’ve extended our revolving credits facility to a 100 million from 80. We still are in a much stronger setting in this sense than we were prior to the global financial crisis in 2008. It’s not about making changes now so to speak, it’s sort of -- it is more preparation months and years in advance of this.
Interviewer: Okay, so there hasn’t been any sort of revaluation of the way you look at risk or anything like that because you were doing that already.
Alan Gauld:That’s not to say there might not be some change in the way that we look at things going forward, I mean hand on heart, we didn’t model out every -- well we did not model out the risk of a global pandemic when we considered our co-investments before. That’s something we will likely do now. Obviously, certain sectors will be a lot more sensitive to -- beat yourself up about that, I mean how many people did do the downside case around a global pandemic, and I think that will be common place now. As I say I don’t think there will be a change in the way that we assess private equity managers and income funds. We look for managers that can endure different cycles, different points in the cycle via differentiated sourcing of deals or value creation capabilities and have learned lessons from difficulties in the past.
I don’t see us changing our approach to diversification. We have over 400 companies. We don't really want a single sector of country to be more than 20% of portfolio NAV. There has been a shift in our portfolio in recent times to more sector growth, resilient sectors like technology and healthcare. For example, in 2015 technology and healthcare was a combined 18% of portfolio NAV, now it is over 30%.
The one change we might -- well, we are making frankly. For the rest of the financial year 2020 we’ll likely reduce our commitments to new funds. There will be less European fundraisings in the remainder of this year that does interest us in any case, just with the uncertainty and just until we realize how things are panning out. We’ll be opportunistic around co-investments, but again there we will probably fall in line with the following merger and acquisition activity and will remain opportunistic.
There's likely to be more secondary opportunities which is basically buying a fund, a private equity fund from another investor part way through the fund’s life so that our deployment rate may pivot that way naturally. But, yeah I don’t think other than perhaps assessing the global pandemic risk when we’re making the investments, I don’t see us fundamentally changing the way that we assess opportunities.
Interviewer: Okay, and in light of that, is there an advantage to running an investment trust structure in this environment? You got less pressure with fund flows, you can possibly be in a better position to buy distressed assets if they come on the market and that kind of thing.
Alan Gauld: Absolutely, I think the situation last year with Woodford showed the advantage of the closed ended model in terms of managing illiquid assets such as private equity. We don’t have to deal with redemptions and hold back cash for that or potentially undertake a fire sale of our assets. It gives us stability and advantage there. As I said, I think we see the opportunity being in secondaries, secondary activity tends to increase in a period of market dislocation or crisis, as investors in private equity perhaps come under liquidity or allocation pressures and need to rebalance their portfolios by selling some of their exposures in private equity asset. We have an established track record in the secondaries and a team of nine investment professionals that look at this week in week out, and so we’re well positioned to identify the opportunities for our Standard Life Private Equity Trust. I think that’s the area that we should be able to be aggressive around, and certainly the investment trust structure helps us.
Interviewer: What about the gearing levels on the trust? I mean is that something you are using at the moment?
Alan Gauld: Right now as I speak, we have over 60 million Sterling in cash and short span investments and we also have an undrawn 100 million revolving credit facility, which I mentioned earlier. We feel we’re in a good position and a better position than what we went into the global financial crisis with. That said, we do anticipate the COVID-19 and the crisis will mean that there is more of a cash burden on us, that’s due to a likely drop in cash distributions from private equity funds due to the drop in merger and acquisition activity, i.e. private equity funds will not sells many of their underlying companies as they would have done before.
This will also on the flipside be offset by a decrease in drawdowns or calls from private equity funds, but that will be at a later stage in the cycle than the fall in distribution due to the repayment of fund credit facilities, due to the need for private equity managers to inject further equity capital to support some of the existing portfolio companies. What I mean is drawdowns will outpace distributions for a time and obviously have a detrimental impact on our cash. But the good news is that we were prepared for this, and that's exactly why we held surplus cash and endured the cash drag on returns during the good times. It was for a rainy day like this frankly, in terms of gearing, a hundred million revolving credit facility in total equates to roughly around 14% of our net assets, so gearing even in the worst case it should be assessed.
Interviewer: Okay great, and then just finally, I was wondering if you could outline some of the arguments for retaining exposure to private equity in these market conditions.
Alan Gauld: Yeah, well from my perspective I get comfort on our existing portfolio in the Standard Life Private Equity Trust due to the quality of the managers which hopefully I’ve outlined, the diversification which we talked about. The fact that the funds have the capital available to support their underlying companies through the crisis, the greater flexibility in underlying company's debt structures relative to the 2008 and the GSC, the fact that covenant light packages are more commonplace, there's a higher equity as a percentage of enterprise value. That will give more flexibility to the companies to trade through this. I get comfort personally from the Trust’s balance sheet position which we've talked about.
But in terms of the more broadly I mean we don't believe in market timing in private equity, it’s a long term asset class. That said, as you look forward, private equity managers are typically adept to picking up assets at good prices in times of crisis or dislocation. There will be an opportunity for the best managers to pick up quality assets just that little bit cheaper than in the recent past. Our team has been investing in private equity since the late 80s, 90s and we’ve seen this time and time again that the vintages post crisis are often the best performing for those reasons. You will see distressed sellers, you will see public to private transactions, you will see carve outs from corporates. These are transactions where private equity has shown time and time again it can really add value.
I will say as well the private entity continues to evolve and is specializing in particularly areas such as digitalization of companies, responsible investment, real secular areas that will shape the companies of the future, so all of that gives me the confidence in the asset class and why I would argue for retaining exposure to private equity during these conditions.
Interviewer: Great, okay, we’ll leave it there. Thank you so much Alan for your time today and to our listeners for tuning in. You can find out more about the Trust at www.slpet.co.uk and please do look out for future episodes.
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