Financial distress can be a profitable alternative investment, provided you have the cash to rescue otherwise viable companies from a financial pinch or even circumstantial bankruptcy. Sponsors of distress debt funds have been stockpiling cash in anticipation of the next economic downturn and are now armed to the teeth with the financial resources to profit by aiding of troubled companies struggling to pay their obligations. What they could not have anticipated is that the United States was in the midst of its longest economic recovery and expansion in the country’s history, and now it is the holders of distressed debt funds in need of relief.
Investors have committed $136 billion to the cause since just 2017, according to Preqin. But, having grown weary of waiting for returns on those commitments, investors have been in speedy retreat, putting the distressed debt business on track to record its worst fundraising year since 2009. A mere four distressed debt funds have raised only $2.5 billion through mid-May, even as overall private debt fundraising has reached record levels.
With the economy still pegging along, distressed debt funds have struggled to find good targets to deploy their funds, and the few deals available have turned into hotly contested competitions among rival distressed debt funds. That has hurt returns. The peddlers of financing to companies distressed by unmanageable debt loads have, in past years, returned more to investors than private equity funds, according to the data firm eFront. Internal rates of return that stood at 12 percent a few years ago have slumped to 8.5 percent.
Bloomberg reports distressed debt fund sponsors are sitting atop about $80 billion of investable cash, almost enough to buy the entire distressed U.S. market at face value. Even though there are signs of economic slowing and perhaps an impending recession, interest rates have remained low and are likely to go even lower, giving most companies the breathing space needed to remain solvent.
Tiring of the wait, fund managers including Oaktree Capital, Ares Management and Brookfield Asset Management are searching for opportunities among smaller U.S. companies, as well as companies in Europe, China and India, Bloomberg reports.
Oaktree is one of the largest distressed debt managers, with roughly $20 billion of assets committed to giving a helping hand to financially burdened companies. Yet the organization’s CEO, Jay Wintrob, said at a May conference: “The amount of tradeable distressed opportunities is very, very modest.”
At this point bad economic news would be good news for managers of distressed debt funds, as they keep waiting for a recession that never seems to arrive.
Mike Consol (email@example.com) is editor of Real Assets Adviser. Follow him on Twitter @mikeconsol to read his latest postings.