Distressed debt funds should probably be growing but they’re not

Investors seem to be holding back despite the impending end of the current cycle

Distressed debt funds should probably be growing but they’re not
Steve Randall

One of the winners at the time of the Global Financial Crisis has failed to show growth despite many investors feeling that a correction could be ahead.

Distressed debt funds peaked in 2008 with a record fundraising of $45 billion but that record has not been equalled according to a report from industry analysts Preqin.

Even though 61% of private debt investors think the equity market is at a peak in 2019 and 35% expect a correction within the next 12 months, funds are not seeing the same strength of a decade ago; fundraising has totalled just $2.5bn in 2019 so far and 2018 as a whole saw 25 funds secure $23bn.

Distressed debt AUM has grown from U$165bn to $226bn between December 2013 and June 2018, but this has been weighted toward dry powder. Available capital has grown by 82% in this period, compared to 19% growth in the value of unrealized assets.

“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,” commented Preqin’s head of private debt Tom Carr.

He added that this may be partly because investors believe sectors like direct lending, which was early-stage 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 $87bn in dry powder to work before committing further capital,” said Carr.

Performance lagging
As well as investors showing lacklustre interest in distressed debt funds, the performance of these funds has also been weak compared to 2008.

Mezzanine funds and direct lending vehicles gained 16.1% and 6.6% respectively in the year to the end of September 2018, while distressed debt funds lost 1.14% on average in the same period.