Blain’s Morning Porridge 24th April 2025 – Private Assets, Contagion Risk and Opportunity.
“You can check out any time you like, but you can never leave….”
There are growing concerns the Private Equity market may be the trigger for the next financial crisis. Alternative Private Capital Markets lack of transparency – but have been a fantastic source of returns. The key point is in crisis there are losers, but also winners willing to address risk.
They say there at 27 doors marked Enter to Hell’s Stock Exchange – but only one marked Exit. In 2007 it was concerns about the sub-prime housing market that ignited the crisis that swelled into the Global Financial Crisis and the collapse of Lehman. Will Trump’s current Tariff Tantrum precipitate a new market crisis? What will the spark for a market crash be this time? Lots of folk reckon it will be the doubts now crystalising around Private Equity and the wider Alternative Private Capital Markets.
One of my key Blain’s Market Mantras is: “The time to sell is before you first think about it.” You might already have missed it. However, we also know the most successful investors are long-term. All crises in financial markets eventually pass.
Some of the largest asset allocating funds are seeking to scale back their PE exposure. Let’s see how that goes, and if the PE market can absorb a rush for the exit. I was reading about Yale University, (a Polytechnical in the US apparently), which has 15% of its $42bln endowment in PE. It wants to sell PE to invest in more liquid assets. It’s concerned the slowdown in IPOs means it’s not been earning sufficient returns from its’ PE investments.
They’ve been talking to consultants about selling their positions for months. The issue around all forms of Private Capital is that its definitionally less liquid, and in times of crisis the exit doors are likely to be closed because of the lack of transparency on price discovery, or any trading history on the asset which is typically bought and held to maturity.
There does seem to be a financial rule that as soon as you identify a coming No-See-Um threat, it won’t materialise! But, if a crisis in private assets does kick off, then it’s inevitable both good and bad private investments will suffer. Investors will have to decide whether to sell at a fire-sale prices, or run the risk.
That’s an opportunity. Not all alternative assets will prove bad investments – generally Private Credit deals are very robust and better mitigated than public hi-yield transactions. During the GFC that began in 2008, folk who had the nerve to hold crashing illiquid assets generally came out whole.
My most successful trade during the GFC was to buy distressed bank Tier 1 and Tier 2 debt at massive discounts as panicked investors feared global banking meltdown. I took the bet that the authorities and central banks could not let a domino collapse of the global financial system occur, but that many struggling banks would be “bailed-out”. That’s pretty much what happened. Equity investors in bailed-out banks were wiped out, but debt investors generally got repaid at par. (That particular advantage of being a debt investor with equity-like returns was quashed by regulators introducing contingent capital (CoCos) which reversed the subordination ladder, mean the riskiest debt investors now get wiped out first! Investors in Credit Suisse and failed Spanish banks have discovered this to their cost))
At one point even some of the strongest banks – many not primarily exposed to the underlying issues around the GFC – saw their sub debt trading at 50% plus discounts due to contagion. Within months they were back to par.
There are, however, some major differences between how a global banking crisis evolved, and how a potential crisis that could occur in Private Assets. For a start, it’s going to be asset managers in trouble – nursing apparent losses on illiquid investments which should only become a crisis when they have to be sold to meet long-term liabilities (like paying pensions or insurance claims). Margin calls on leverage is another matter – and could trigger meltdown.
When banks fail, they fail fast as they can’t fund themselves in a liquidity crisis. How would regulators agree on any support for asset managers hit by an asset crisis? One route might be to ensure there was liquidity through easy money, like widening repo collateral windows, or risking a repeat of QE distortions.
There are said to be over 30,000 private companies owned by, or invested in, by US Private Equity Firms. The PE firms seek to earn fees managing these assets for other investors, by leveraging them up with debt to pay themselves dividends, and selling them. It’s been one of the most attractive fee-earning sectors of the market, and one of the most attractive for funds to put “alternative” asset allocations into. Fundamentally, it’s a form of equity risk – often leveraged.
Suddenly it’s become a market beset with uncertainty, inflation and recession fears, concerns as to what long-term damage Trump’s tariffs might have done, and now doubts as to the future of the dollar and the Treasury Market. As a result, the door marked exit for privately held firms is closed – the big PE firms are struggling to sell “mature” portfolio firms.
That could trigger a raft of first, second and third order derivative problems – which have the potential to spawn consequences all of their own – including the big one; contagion risk. Here are some crisis vectors:
- PE firms will struggle to meet drawdown requests from investors – in a blocked market you can only sell what you can, not what you want to sell, thus to raise finance they have to sell good assets, causing their own credit quality to drop as they are left with increasingly risky assets. (Guess what; PE firm valuations are down 20-25% this year!)
- Faced with limited amounts of new “dry-powder” from investors, a closed IPOs market, or a dearth of portfolio-sales opportunities in a recession, would block PE firms from funding new ventures – putting a break on new company formation, creating a contagion risk as something would clearly be “awry” with the economy.
- The FT reported a few days ago that Chinese investors have been ordered to pull out the US PE market, but other global investors are seriously concerned about the political competency aspects of Trump’s US administration. Suddenly the US looks far less attractive – another factor contributing to international investors exiting the US exceptionalism trade.
- The lack of IPOs leads to rising concerns about the marketability of all existing PE investments – ultimately triggering a negative doom loop.
- Highly leveraged PE owned firms (which have used to debt issued by portfolio companies) will struggle to refinance as markets slow and credit spreads widen, leading to defaults, creating further doubts on the quality of PE portfolios, which will swiftly contage the Private Credit markets as fears of a junk/PC liquidity crisis catalyse further drawn down requests.
It’s easy to see why institutional money allocated to PE managers is suddenly a risk. However, smart money that understands PE risk will be looking at any crisis as a screaming investment opportunity. Smart money will be seeking to pick up distressed Private Equity and Private Capital trades as the pressures mount. At the right fire-sale prices there will be substantial returns to be made buying the stronger PE names.
As a final point, are any investor groups particularly vulnerable? One of the sectors to consider the US Universities – already under attack by Trump threatening to block their charitable status and tax them more. That’s another risk to add to the Trump charge street – creating a market crisis by deliberately bankrupting investment firms seen to be disagreeing with him!
If you are invested in private assets and are looking for advice or to exit – that’s exactly what my business Windshift Capital is engaged in. Give me shout to discuss!
Out of time and back to the day job.
Bill Blain
Author Morning Porridge
Founder Windshift Capital
Partner Shard Capital
