Friday Letter: Ahead of the curve this time

 US public pension are committing to distressed funds now, before the next downturn. That might be smart.  

When the 2008 market crash hit, the talk at investment industry conferences immediately turned to distressed debt. And public pension funds, eager to make money from the strategy, began searching for managers in the space.

But given the bureaucracy involved in approving new investments at public pensions, some inevitably missed the wave.

To be fair, even though public pensions do take a painstakingly long time to approve new investments, distressed debt as an investible asset class didn’t have huge profile until the after Lehman Brothers fell.

This time, things might be different. Several large public pension funds have pounced on new distressed offerings recently. For example, the Los Angeles County Employees Retirement Association, the Ohio Police & Fire Pension Fund, as well as the State of Colorado, committed capital to Glendon Capital Management, a distressed focused spinout from Barclays that launched last year.

Other plan managers have been writing checks to larger, more tenured private debt players such as KKR, Oaktree Capital Management and Avenue Capital Group. The Maine Public Employees Retirement System recently invested in the KKR Special Situations Fund II, while the Kentucky Teachers Retirement System gave $10 million to the Oaktree Opportunities Fund X, a global distressed fund that’s targeting a whopping $10 billion.

Are these allocations being made too early? Maybe not. For one thing, some are heralding the tumbling oil price as a potential catalyst for another significant downturn. Oaktree’s Howard Marks, in his December investor letter, said it was his belief that the disruption in energy could play exactly that role.

KKR is focusing its special situations fund on energy too, along with a stated appetite for Asia. And Avenue and The Carlyle Group are also in the running with energy-focused distressed funds; both firms recently received a pledge from The Pennsylvania Public School Employees Retirement System.

It is of course possible that the capital being earmarked for these funds won’t see much action for a while yet. For those investing with Oaktree, it helps that no fees will be charged until the capital start getting deployed. Other GPs might consider using such ‘dry-close’ mechanisms also.

In the meantime, any pension CIO worrying whether they’ve moved into distress too soon this time around should bear in mind two things: No. 1, timing the market perfectly is virtually impossible. And No. 2, if you’re serious about distress, getting in a bit too early is still a whole lot better than getting in too late.