A majority (90%) of U.S. private equity fund managers expect to see a rise in the volume of distressed fund transaction activity over the next 12 months, according to the results of a survey from Intertrust. Due to the impact of COVID-19, almost half (46%) of respondents believe that mismatches in valuation expectations between buyers and sellers will restrict deal flow.

Intertrust interviewed around 150 private equity fund managers across Europe, North America and Asia to identify the risks and opportunities facing the industry in light of the COVID-19 pandemic.

Distressed strategies are also likely to benefit from an improved fundraising climate, which for most other fund types is expected to worsen. According to the survey, 81% of respondents in the U.S. expect the fundraising climate for distressed funds to improve over the next 12 months, of which 39% said it will significantly improve. Venture funds are expected to see the biggest drop in investor appetite with 79% predicting fundraising conditions will worsen.

As the private equity sector adjusts to a rapidly transformed landscape, the study revealed a growing interest in the role that private debt can play during and after the crisis. Over a fourth (29%) of private equity investors in the U.S. are planning to diversify into direct lending strategies over the next year.

Despite the volume of dry powder in the market, the research highlighted the underlying sentiment of caution gripping the private equity industry. Nearly three quarter (73%) of U.S. investors expect private equity firms to be driven by the need to stabilize the financial health of portfolio companies, while more than half (54%) believe GPs will be ‘in defense mode’ until the impact of the virus is fully understood.

In terms of measures being adopted by GPs as a direct consequence of COVID-19, the most common is fund term extensions, as 76% expect to see term extensions for funds nearing the end of their term to be introduced to allow more time for deployment.

Despite the challenges ahead, the study revealed that there remains some positivity in the industry. Nearly a third (31%) of U.S. respondents believe the environment for private equity will improve and around half (47%) said they are optimistic the industry will be able to face the pandemic and, ultimately, come out stronger over the next two years.

“Our study reveals that distressed-led activity is set to be a defining theme for the year, with the existing high levels of dry powder in the market expected to act as a catalyst for high-profile market transactions,” James Ferguson, head of Americas at Intertrust, said. “While the COVID-19 pandemic represents one of the biggest tests the U.S. private equity industry has ever faced, the sector is proving its adaptability in the face of such risks. For those U.S. firms brave enough to enter the market in the next 12 months, they could find tremendous opportunities even though fund term extensions point to a sustained slowdown in deal flow.”

Intertrust is a provider of tech-enabled corporate and fund solutions to clients operating and investing in the international business environment.