Why 2019 was a uniquely distressed year

Last year saw the lowest level of private debt fundraising since 2014, indicating that the asset class may be losing its sheen. However, there is one area of private debt that is bucking the trend, with distressed debt fundraising climbing in 2019 and raising more capital than any other strategy, according to the Private Debt Investor 2019 Fundraising Report.

Figures from the PDI database reveal Distressed debt made up 36 percent of the total raised in 2019, making it the largest strategy in terms of fundraising, coincidentally for the first time since 2014. However, the strategy actually saw an even larger fundraising back in 2017, which by all metrics was a truly exceptional year for private debt fund activity. Distressed fundraising peaked then partly due to the inclusion of Apollo’s $24.7 billion vehicle which invests into both distressed equity and distressed debt and boosted the distressed fundraising total to $74 billion, but 2019 saw more than $50 billion raised by funds holding a final close, higher than 2017 is the huge Apollo fund is excluded. In the interluding year of 2018, only $31 billion was raised for distressed strategies, the lowest amount in our sample by quite some margin.

So what’s going on the distressed space that has caused this unusual behaviour? One factor could be low default rates, which have stuck at very low levels for the past few years and, with evidence of these starting to tick up, potential signs of market distress are becoming more apparent. It could be that market participants were expecting defaults to start rising through late 2017 and into 2018 but this didn’t materialise as the global economic picture became rather mixed, with strong performance in the US, slower growth in Europe and no major economic crisis arose in China or elsewhere in the Asia-Pacific. Investors may be making a renewed push into distressed today as they anticipate slow growth to translate into defaults in 2020.

However, given that there was no economic or financial system crisis through 2018 and, while growth was slow in many regions, there were no signs of a global recession, this could mean that the glut of 2017 fundraising remains largely undeployed and there could be substantial dry powder out there today. It’s difficult to tell what the impact of this will be, but it could mean there will be intense competition for the best distressed assets in the coming years as fund managers seek to put their vast capital reserves to work.

But there is also a risk that relatively lax lending documentation and cov-lite could have kept many distressed companies out of the limelight through the past couple of years, building up problems that the market simply isn’t aware of, but which will eventually come to light. However, when these assets do finally become distressed, they may be in such a bad financial situation that they simply aren’t suitable for a turnaround, they will be beyond saving.

Five of the 10 largest funds closed since 2014 are distressed in focus meaning there are some absolutely huge funds to be put to work in the distressed space, and the top performing managers have strong track records in the distressed investing, often throughout the cycle, not just during downturns, so if anyone is likely to be able to put that capital to work, it’s the big fundraisers that dominate this space.