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Distressed Debt Funds Stall in 2019 Under Weight of Dry Powder

May 24, 2019, 08:50 AM
Filed Under: Industry News
Related: Preqin

Distressed debt has long been a major component of the private debt industry. At the time of the Global Financial Crisis (GFC) distressed debt funds raised record levels of capital and saw record performance, as funds took advantage of distressed opportunities.

The majority of investors now feel the market is at a peak again, and 35% expect a correction within the next 12 months.

But distressed debt funds have not yet seen the same uptick that they witnessed in 2008, a new report from Preqin finds. For the time being, the strategy remains less attractive to investors than either special situations or direct lending funds, and fundraising has totaled just $2.5 billion in 2019 so far. Performance has been lackluster too, lagging both mezzanine and direct lending funds in the year to September 2018.

According to Tom Carr, Head of Private Debt: “Given that many investors feel we are late in the market cycle, we might expect to see increased interest in distressed debt funds. These vehicles managed to capitalize on the previous major market correction, but investors do not yet seem to be flocking to them in this cycle. This may be partly because investors believe sectors like direct lending – which was very much a nascent industry in 2008 – will offer better opportunities in a downturn. But it may also be simply a case of capital build-up. While the unrealized value of assets held by distressed funds has grown by 19% since 2013, dry powder has ballooned by 82%. Investors may be waiting for managers to put some of their $87 billion in dry powder to work before committing further capital.”

Distressed debt fundraising reached a peak of $45 billion in 2008 – a record that has never been equalled. Sixty-one percent of private debt investors think the equity market is at a peak in 2019, and 35% expect a correction within the next 12 months. But the first five months of 2019 have seen just four distressed debt funds close, raising $2.5 billion. 2018 as a whole saw 25 funds secure $23 billion.

The largest proportions of investors believe the best opportunities are in direct lending (44%) and special situations (43%) funds. But distressed debt is the third most sought-after, with 36% of investors targeting it.

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