Key Takeaways
- • US M&A deal value collapsed 60% quarter-on-quarter in Q2 2020 and fell 50% year-on-year, reflecting severe market disruption from the coronavirus pandemic and weakened investor sentiment.
- • Deal-level gross DPI (Distributions to Paid-in Capital) returns are softening across vintage years, with 2012-2013 cohort deals showing only 0.75x and 0.51x median DPI respectively despite being seven to eight years into their lifecycles, signaling subdued exit activity.
- • Post-GFC recovery showed sharp DPI rebound to 1.50x median in 2009, but subsequent vintage years experienced declining returns, establishing a cautionary pattern for current market stress scenarios.
- • LP transparency and accurate NAV reporting become critical during market crises, as investors face potential covenant-linked asset allocation rebalancing requirements tied to write-downs in private equity portfolios.
- • Continued softening of DPI returns depends directly on pace of exits and realization proceeds; without acceleration in deal activity, distributed cash returns will remain depressed.
Summary
The CEPRES Private Capital Market Outlook released in late August 2020 documents a sharp contraction in private markets activity during the second quarter of 2020. US M&A deal value declined 60% sequentially from Q1 to Q2 and fell 50% year-over-year, reflecting the acute market dislocation and investor risk-off positioning triggered by the coronavirus pandemic. This dramatic pullback in dealmaking activity has direct implications for the realization of returns across existing private equity portfolios.
The report highlights a concerning trend in deal-level DPI performance across multiple vintage years. While post-financial crisis recovery showed median gross DPI rebounding sharply to 1.50x in 2009 compared to deals with 2006-2008 investment years, subsequent cohorts have experienced persistent return compression. Deals from 2012 and 2013 vintages are now seven to eight years into their investment periods but are generating only 0.75x and 0.51x median gross DPI respectively—indicating that distributions to investors remain well below their initial capital commitments. This pattern suggests that the initial rebound from the GFC was exceptional, and normalcy involves significantly lower distributed cash returns during comparable holding periods.
The softening of DPI returns is directly tied to the pace of exits and liquidity realization. As deal activity contracts sharply due to market stress, portfolio companies face extended holding periods and delayed exit opportunities, which constrains the ability of GPs to return capital to LPs. This dynamic creates dual pressures on institutional investors: not only do they face paper losses on unrealized NAV, but they also experience delayed cash distributions that may trigger asset allocation covenant violations if NAV write-downs force rebalancing against other portfolio holdings.
Dr. Daniel Schmidt, Founder & CEO of CEPRES, emphasized that transparency and accurate reporting become paramount during crises. LPs depend on private equity allocations to generate alpha for liability underwriting, but they simultaneously face asset allocation constraints through NAV covenants. Investment analytics technology that provides accelerated, detailed portfolio analysis helps institutional investors make timely rebalancing decisions and work collaboratively with GPs during periods of market stress.
The report highlights a concerning trend in deal-level DPI performance across multiple vintage years. While post-financial crisis recovery showed median gross DPI rebounding sharply to 1.50x in 2009 compared to deals with 2006-2008 investment years, subsequent cohorts have experienced persistent return compression. Deals from 2012 and 2013 vintages are now seven to eight years into their investment periods but are generating only 0.75x and 0.51x median gross DPI respectively—indicating that distributions to investors remain well below their initial capital commitments. This pattern suggests that the initial rebound from the GFC was exceptional, and normalcy involves significantly lower distributed cash returns during comparable holding periods.
The softening of DPI returns is directly tied to the pace of exits and liquidity realization. As deal activity contracts sharply due to market stress, portfolio companies face extended holding periods and delayed exit opportunities, which constrains the ability of GPs to return capital to LPs. This dynamic creates dual pressures on institutional investors: not only do they face paper losses on unrealized NAV, but they also experience delayed cash distributions that may trigger asset allocation covenant violations if NAV write-downs force rebalancing against other portfolio holdings.
Dr. Daniel Schmidt, Founder & CEO of CEPRES, emphasized that transparency and accurate reporting become paramount during crises. LPs depend on private equity allocations to generate alpha for liability underwriting, but they simultaneously face asset allocation constraints through NAV covenants. Investment analytics technology that provides accelerated, detailed portfolio analysis helps institutional investors make timely rebalancing decisions and work collaboratively with GPs during periods of market stress.
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