Confidence in distressed is growing again

Distressed debt fundraising is one of the most cyclically affected strategies in private credit, and in the first half of 2019 it was back with a vengeance, writes John Bakie.

Unsurprisingly, distressed debt funds tend to be most popular late in the credit cycle and do less well in more benign market conditions, which leads to major swings in fundraising activity. With most industry experts expecting a change in economic fortunes in the near future, it is no surprise to see that distressed debt fundraising was booming in H1.

PDI’s statistics show that more than $35 billion was raised for distressed funds during this period. This was more than for any other strategy, including senior and subordinated debt. By comparison, in the second half of 2018 just over $4 billion was raised for distressed debt strategies globally.

However, this is not the first time during the current credit cycle that there has been a boom in demand for distressed debt. Back in the first half of 2017, when private credit generally was seeing unprecedented levels of fundraising, distressed vehicles raised $51 billion from institutional investors.

That now appears to have been a false dawn. Although there was much talk about the severe economic consequences of international events, including aggressive trade rhetoric from the newly elected US President Donald Trump and the UK’s recent decision to leave the EU, a recession did not materialise. On the contrary, the global economy entered a new phase of growth that limited the scale of distressed opportunities available for fund managers.

Opportunities ahead

However, if you wait long enough then a recession becomes a certainty, and more recent developments may be once again presenting fertile ground for investors in distressed debt. Although the global economy is still growing, there are signs of weakness. Germany’s GDP has stumbled in recent quarters, and the UK is starting to feel the impact of uncertainty owing to its failure to ratify an agreement over its planned exit from the EU.

While a turn in the credit cycle may not yet be imminent, the signs of more difficult market conditions are beginning to appear. Some sectors are already running into difficulty.

Retail in particular has been hit by reduced confidence in the short term and by more long-term shifts in shopping habits. The latter may offer distressed players opportunities to restructure the businesses affected.

Many of the top 10 funds raised during the first half of 2019 were distressed-debt vehicles, with two from Lone Star leading the pack. Lone Star Fund XI raised $8.2 billion while the firm’s Real Estate Fund VI raised $4.7 billion. Three other distressed funds make the top 10: GSO Energy Select Opportunities Fund II with $4.5 billion; Cerberus Global NPL Fund with $4.1 billion; and American Industrial Partners Capital Fund VII with $3 billion.