How PE firms can manage portfolio risk in unchartered waters

Risk management

As the global economy is entering a recession following the global coronavirus pandemic, business activity grinds toward a halt worldwide. What will this mean for the health of GPs' portfolios and how can the risks be managed in an effective way? 

Private equity firms and their portfolio companies come into this current economic crisis riding a decade-long wave of growing transaction volumes, valuations, and fundraising. 

According to a recently published research paper by McKinsey, that position of strength may prove a bulwark in the months ahead, especially for firms that have exercised prudence recently. 

“But there are also fault lines in private markets: deal leverage recently reached a new high, and multiples paid in recent months reached a multiyear high,” said the report.

For private equity investors, a global crisis of this magnitude will mean troubled portfolio companies and delayed deal making processes.

And it seems that this virus outbreak is fundamentally unique in its disruption of core working processes for firms and businesses worldwide. There are a few different strategies to tackle this so as to make the waters a little bit less choppy.

As more and more workers adopt the working from home policy in order to protect themselves and others, this new way of working could take some time getting into the swing of things and just being comfortable with remote team work.

With regards to portfolio companies, private equity firms need to provide training for all employees to get comfortable with new operating models and to make sure they can work from home in an effective way.

Moreover, “firm leaders need to role-model the emerging best practices and ensure their presence, through videoconferences or more frequent informal calls, to maintain both organisational connectedness and ongoing critical activities,” according to McKinsey.

“PE firms need to keep crucial machinery running; they should continue to assess the investment pipeline, conduct investment-committee discussions, and manage all other essential processes through videoconferencing. Similarly, they can continue regularly interacting with portfolio-company leaders through videoconferencing and shift to conducting board and review meetings virtually,” said the global consultancy firm’s report.

It added: “Firms might consider increasing the frequency of interactions, thus reducing lead time on agreed actions. This would allow maximum flexibility and agility for responding to fast-emerging challenges and making quick, risk-mitigating decisions; such as halting an exit.

Other portfolio priorities include: support and course correction, ensuring that supply chains are operating optimally if they are part of the frontline response or provide important products and services during the outbreak; such as healthcare and retail companies.

Sectors that are immediately affected by the global health crisis, including travel, hospitality, entertainment and luxury sectors, have naturally seen massive drops in consumer demand. Here, investors will need to decide where best to allocate the limited time and resources at hand. 

For example, in cases where portfolio companies are dependent on international supply chains, there is a rapid need for executives to create regional alternatives for critical parts in order to maintain operations.