Private equity liquidity hit by 10 per cent VaR caused by Coronavirus Crisis

CEPRES, a provider of portfolio forecasting for Private Markets, is advising clients to use 10 per cent VaR (Value at Risk) forecasts for 2020 and 2021 due to the COVID-19 outbreak. 

CEPRES projects outcomes for more than 100 Institutional investor portfolios around the world including pensions, insurers and endowments based on their “PE.Forecast” software. The technology runs 100,000s systematic and idiosyncratic Monte Carlo based scenarios to build distributions for future portfolio liquidity, NAV and returns. 

By studying previous crash scenarios and comparing to the impact of the current crisis, CEPRES experts are now applying a 10 per cent VaR liquidity forecast to their simulations for the 2020 and 2021 projections. Also, CEPRES econometric experts have updated cash flow patterns with a shock scenario incorporated into the PE.Forecast software for all clients in order to calculate median-projections based on the new market situation.

Further details of model assumptions:

• The current shutdown will impact private equity, private real estate, private debt funds, infrastructure and direct investments.

• No net distributions for the next 6 months (until Q4 2020), and subsequent distributions reduced by up to 50 per cent from Q4 2020 to Q4 2021 (depending on fund’s maturity).

• Reduction of up to 50 per cent in fund contributions compared to normal market expectations for the next 6 months. Although it is less likely many new investments will be made, existing investments may need increased liquidity because of the difficult economic environment. Funds may also call capital to build cash reserves to alleviate investor liquidity constraints in the next months.

• Cash flow patterns will return to normal market conditions from Q4 2020 for contributions and Q4 2021 for distributions.

• We predict valuations and hence returns in 75 per cent of traditional industries will struggle to recover to pre-crisis levels due to a new orientation of global production supply chains & efficiency. Technology & digitally orientated business models will benefit from the crisis and surpass historical valuation and exit prices in the mid-term.

• Overall 10 per cent reduction in long-term market return expectations based on money multiple (MOIC); return adjustment depending on fund vintage, entry multiples and industry focus.

•  Increased correlation coefficients between investments in portfolios. Due to the economic shock, the systematic risk in the short-term strongly dominates idiosyncratic (diversifiable) risk especially for traditional businesses. Thus, it is possible that a significant portion of investors’ portfolios will either suffer further, or (hopefully) recover faster based on market factors decoupled from single manager or investment driven determinants.

Dr Daniel Schmidt, Founder and CEO, says: “Several regulatory authorities mandate liquidity stress testing as an AIFM risk management obligation for fund managers. The Luxemburg based CSSF recently issued the IOSCO recommendation 19/733 making investment managers liable for an audit trail on their liquidity forecasts. With a 15 year track record, our PE.Forecast modelling is the leading technology with practical experience during crises like the GFC to help investors, fund managers and government bodies to evaluate and manage their risks.”
Dr Ulrich Häberle, Head of Quantitative modelling, adds: “In many cases, PE.Forecast is applied for liquidity stress testing where future capital calls are planned to be served by forthcoming capital distributions from the funds. In order to avoid liquidity shortfalls, we recommend now to make liquidity decisions based on a 10 per cent VaR scenario.”