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The world’s biggest distressed debt funds are gearing up to capitalize on the worst market turmoil in decades as they look to snap up the debt of troubled companies at deep discounts.
The near shut down of the global economy has left plenty for the vulture funds to feed on—although competition could be fierce.
“There are now huge opportunities for distressed debt funds, particularly in the transport, retail and hospitality sectors,” Stavros Siokos, managing partner at real estate asset specialist Astarte Capital said.
“Even core assets which are supposed to be risk-free, such as infrastructure, are at risk which is something we never expected to see in our lifetime,” he added.
For distressed debt investors and private equity firms with specialist funds, buying the bonds of companies in financial difficulty can lead to better returns as they are compensated for the higher risk they are taking. The hope is that once a company’s financial health recovers and the bond price goes up, they can make a profit.
There is no shortage of cash available. In the last five years, distressed debt funds have raised $130.6 billion across 128 strategies to invest in troubled companies, according to data provider Preqin. And more money is being raised.
On April 8, there were 50 funds in the market, looking to raise a total of $34.8 billion, Preqin said. Apollo Global Management APO, -5.80%, one of the world’s biggest investors, told investors in early April that it had invested $10 billion into credit and private equity in March, and that it is looking to raise a new vehicle to find opportunities, WSJ reported.
Citing people familiar with the matter, the WSJ also wrote that General Atlantic is teaming up with credit investor Tripp Smith to launch a nearly $5 billion fund to provide financing to companies hit by the coronavirus pandemic.
J.P. Morgan Asset Management launched its first-ever special situations fund in November, raising just over $1bn to invest in stressed, distressed and event driven situations across North American and European private and public credit markets; while private equity firm CVC closed its global special situations fund in June on $1.4 billion.
Default rates have remained low for 10 years, according to managing director Brendan Beer at Oaktree Capital, as companies borrowed and re-borrowed, thanks to easy and cheap credit. He says now cyclical default expectations are being pulled forward.
At the end of March, Fitch Ratings revised the 2020 forecasts for European high-yield corporate default rates to 4-5% for bonds and 4% for loans, up from its initial forecast of 2.5% for both. They expect bond and loan default rates to increase further in 2021 towards 8% and 7%, respectively.
“Recent pricing moves indicate that default rates could be set to spike on a very large and potentially vulnerable global debt stack, which may create an enormous opportunity set for distressed debt funds, particularly those focused on opportunities outside the U.S.,” said Patrick Kenney and Santiago Pardo, portfolio managers in the credit investment team at Man GLG, in a recent report.
Katie May, director at InCloudCounsel, a legal technology company, said she had seen a sharp spike in the number of clients looking at distressed debt opportunities in the last two weeks. “We were surprised by the speed at which we have seen interest increase. Distressed debt investors have been waiting patiently during the long bull market,” May said.
InCloudCounsel teams up with law firms to handle routine legal contracts such as the negotiation of non-disclosure agreements needed to make investments, with the company getting involved with deals at an early stage.
May said distressed debt investors were looking to take advantage of the dislocation of valuations in sectors impacted most as governments world-wide impose restrictions to limit social contact in efforts to tackle the spread of the virus. In the U.K. these include restaurants, pubs and bars, entertainment venues including cinemas and theaters as well as betting shops and sports facilities.
“There are higher quality assets available — healthy businesses who are being affected short-term who otherwise would have had strong balance sheets are now becoming attractive to distressed investors,” May said.
Strategies with more flexible investment mandates can also pivot more toward distressed debt at a time like this, according to Shaun Holmes, who leads the European restructuring and special situations group at Stephens Europe.
Holmes said the investment bank has had a lot of inquiries from both distressed debt and other fund managers.
