Recent weeks have seen a flurry of closings for distressed strategies, with the noticeable absence of that word, writes Robin Blumenthal. Instead, they are called credit solutions, opportunities or special situations funds.
Even Oaktree, with one of the biggest distressed debt portfolios, took the unusual step of removing
the word from its gargantuan $15.9 billion Opportunities fund – the largest private debt fund ever, per Private Debt Investor data – when the firm closed it last autumn.
At the time, Oaktree said the change was to “better reflect how its investment style has evolved and expanded over three decades”. In its monthly Oaktree Insights piece last November, the firm noted that “as the definition of corporate distress has evolved, so too has our investing approach”, and that “key factors affecting the credit cycle” had changed since the platform was founded in 1988, which lowered the cost of debt and made the default environment “more benign”.
Oaktree declined to comment. But per the Insight piece, the US Federal Reserve’s “ultra-accommodative monetary policy played a major role in limiting default activity”, both after the global financial crisis and the capital markets’ disruption precipitated by covid-19 in 2020.
So successful was the Fed’s intervention that fund managers, which had raised substantial amounts of money in spring 2020 anticipating a wave of bankruptcies, barely had time to blink before the opportunities had disappeared.
Bankruptcies overall have fallen to record lows in the past year. But the move away from “classic” distressed seems to have occurred well before the Fed’s actions to stave off a liquidity crisis in 2020. According to PDI data, distressed debt accounted for just 15 percent of all fundraising in 2018, half the share of 2017.
“The reality is that, quote, unquote, distressed was never really only just distressed; historically it’s also included stressed and special situations,” says Jason Dillow, chief executive and chief investment officer of Bardin Hill Investment Partners. He attributes the impetus to avoid the name partly to the muted returns for the strategy from 2010-19. Although he says part of the move away from the name has to do with rebranding, “investors have had to add a lot more arrows to their quiver” because there has been so little classic distressed.
“Distressed is not dead,” says Ryan Mollett, global head of distressed and corporate special situations at Angelo Gordon. But he agrees that it has evolved, to the point where “the classic distressed perspective of ‘loan to own’ has been flipped to one where we are trying to keep companies from filing for bankruptcy, and we’re seeing other managers begin to follow suit”.
Mollett says the firm looks for good businesses that may have an issue with the capital structure, not necessarily those that are experiencing a secular decline, like retailers. Angelo Gordon in May closed a $3.1 billion credit solutions fund that is part of a series of vehicles residing on the firm’s $11 billion “all-weather distressed and special situations” platform.
Part of the change is structural. Dan Zwirn, chief executive and chief investment officer of Arena Investors, notes that after the GFC, “the vast majority of alternative capital raised went to drawdown funds, as opposed to hedge funds”.
Zwirn says that one relatively favourable thing about allocating to a hedge fund is that it gives the manager discretion to go where the opportunities are, rather than a top-down allocation model where “you’re filling SKUs [stock-keeping units] on the shelf” in a particular strategy. Rather than trying to determine what specific classification will appeal to investors, Arena has told LPs that “it’s okay to allow us to invest in what is actually appealing, as that guideline changes more rapidly than the time frames of narrowly tailored funds,” he says.
“History has taught us that the corporate distressed business is incredibly episodic,” says John Kline,co-head of private credit at New Mountain Capital. That can make fundraising difficult. “If you’re not making a pinpoint call on the distressed cycle, you need to have a flexible mandate to pivot to where the opportunities are.”
Even so, this spring saw at least one prominent rescue financing in the corporate public market. Perhaps another distressed episode is on the horizon.