Distressed & special sits report: Overview

The past year has seen increasing appetite for distressed debt and special situations. PDI considers the factors behind the trend.

1. Gathering storm clouds

The narrative of distressed debt and special situations is almost always tied to a conversation about the credit cycle and the broader economic picture. Industry participants have been anticipating a turn in fortunes for the past two years, citing a frothy private debt market, loose deal terms and the potential for another global economic turndown.

By the end of 2016, the last of these was widely perceived to be an imminent threat following shock results in the UK’s EU referendum and the US elections. As it turns out, our worst fears for the global economy have not yet come to pass.

Meanwhile, private debt fundraising did not see the slowdown touted two years ago, with 2017 turning out to an unexpected blockbuster year. That said, the market remains poised for the unforeseen.

2. Growing demand

When it comes to distressed debt investing, the fundraising numbers speak for themselves. The strategy has quietly been gaining ground since a turn in the cycle has looked more likely. It hit an all-time high in 2017 when distressed debt-focused funds raised $61.5 billion – they accounted for over 30 percent of capital raised both in 2017.

In the first three months of this year, distressed debt-focused funds raised $12.3 billion, or 33 percent of the total. But that does not mean the strategy will remain dominant throughout 2018. Distressed debt funds represent just $60 billion of a total $242 billion targeted by funds in market, suggesting fundraising for this strategy may have already peaked, leaving many to focus on deals.

3. Holding patterns

Raising money for distressed debt investing is one thing, deployment is another. As seen in our US market analysis on p.12, the dry powder is there, but without the predicted downturn rearing its head, finding the right deals can be a challenge. Many distressed debt investors are now in a wait-and-see mode.

But it is not all about distressed debt, which is arguably only one part of a broader class of including special situations. Many make a case for distressed debt and special situations being an “all-weather” strategy.

A successful investor is not only able to recognise market dislocations, but also has the sector expertise and local knowledge to navigate hidden pockets of value in the market by offering creative solutions to companies that need it.