The Covid-19 pandemic continues to cause incalculable damage to health, human services and small business globally. Against this backdrop, how are private equity firms and their portfolio investments reacting to, and fairing in, this crisis? So far, quite well.

From an investment standpoint, private equity firms are well-positioned. Record amounts of dry powder provide a competitive edge that allows the PE industry to move quickly and invest money in a down cycle, whether it be through new deal activity or investments. While private equity firms are not jumping into new deal making activity now, they are certainly dusting off their analyses and preparing to put money to work. In general, PE firms are following a three-phase approach to allocating their time during the crisis.

Phase I: Defense

When this crisis first unfolded a few weeks ago, most PE firms scrambled to assess their portfolios. By their nature, portfolio companies are highly levered and have less runway in a time of crisis. PE executives have been working with their portfolio companies to make sure they can weather the storm.

Several options exist to help bolster the balance sheet of a company that might have an issue. The first step is usually to draw down on the revolving credit facility to ensure access to an immediate source of liquidity. Next, PE firms can work with their banking partners to help with structuring amendments and covenant waivers. The Mizuho team is also working on a number of creative solutions, including inside maturity loans, account receivable facilities, and special purpose vehicle facilities at the GP level, among many more. Often such solutions involve a deep screen of the credit agreements and fund creation documentation, to determine the art of the possible. In some instances, support from banking partners will not be enough and certain companies will need additional equity from the fund.

For some portfolio companies that have direct lenders as their banking partners, there is less flexibility. Direct lenders, with some exceptions, have limited ability to extend further capital and help portfolio companies with their liquidity needs.

Phase II: Fast break

While managing the portfolio is an immediate and ongoing focus of most PE executives, many dealmakers are also taking stock of new opportunities in the landscape, many of which are not for the faint of heart. However, if history is a judge, this is where outsized returns can be made. In today’s environment, these consist of rescue capital, portfolio debt repurchase and defeasance, opportunistic debt purchases, PIPEs, sponsor-to-sponsor private minority stake sales and other non-traditional forms of investing.

As the current landscape is fast evolving, these new investment opportunities are often fleeting. Taking the public market as an example, any investor who held out for the bottom missed about 22.5 percent in returns at time of writing, and these returns appear to be rising—at least as of now. The firms that will profit from Phase II are those that are nimble enough to be able to move quickly. These firms typically have funding structures in place already or don’t need partner capital for leverage or co-investment.

Phase III: The long game

While all of us await a return to normalcy, most of us realise that certain things may never be the same. Covid-19 is creating a new normal. Some industries will gain, while others will clearly lose out. For example, online shopping has experienced a surge of demand as Amazon and other online retailers struggle to meet the pace of new orders. Since consumer behavior tends to be sticky, one can imagine that at least some of this increase in demand will likely remain post-crisis.  On the other hand, the cruise line industry, which has suffered a blow to its reputation in recent weeks, will likely struggle. This is an industry that has a disproportionate share of its revenue coming from the elderly population and its ability to bounce back is tenuous.  At best, this will result in a re-rating of its valuation in the medium term.

While multiples across broad industry sectors are settling into fair value levels, it merits double clicking into underlying sub-sectors within each industry, specifically the secondary and tertiary lines of business that feed into the broad industry segments. Who will the winners here be and how does PE find and invest in them? Investing through this requires deep domain knowledge. Those PE firms with dedicated sector teams and industry expert partners as well as strong advisors, investment bankers and consultants will be better positioned to assess these opportunities early and act on them.

To be clear, each PE firm is unique in its investment strategy and capabilities, and will evaluate the crisis through its own lens. Some firms, with newly raised mega funds will be eager to put money to work more quickly (Phase II). Other firms that invested heavily through 2019, will take more of a defensive stance (Phase I). However, as an industry, PE has historically been able to capitalise on periods of volatility and I don’t doubt they will be able to do so again.