As more distressed and opportunistic investment strategies are brought to the market in the wake of the Covid-19 pandemic, a new report from bfinance has detailed seven distinct subcategories within these opportunities to navigate this growing space.
Fundraising has notably stepped up in distressed credit strategies over the past three years as investors seek to "express 'late-cycle' convictions", with the $74.9bn raised in 2017 marking a record for the asset class.
Despite a proportion of these assets remaining as dry powder, the report suggests that the 2020 capital raising figure may beat this record as managers have already shortened fundraising windows and brought expected closing dates forward.
New funds entering the space will face fierce competition from existing vehicles with a substantial amount of dry powder at hand, as well as turn-around private equity managers who have a capacity to shift "enormous firepower" toward distressed debt to gain control of those issuing it.
According to the report, this competition translates to reduced returns for prospective investors, as well as other trade-offs between deployment speed and risk/reward dynamics, although certain sub-strategies are better insulated than others.
Three of the subcategories pertain to dislocated entry, with funds trying to get access to investments at a highly discounted price, while the other four focus on financing, 'evergreen' and multi-strategy.
Dislocated Entry - Private Credit tends to rely on passive recovery and restructuring initiatives to generate value, targeting distressed borrowers or stressed investors to find such opportunities, but the space already has significant competition for underlying positions and may present ESG concerns.
Net of fees, it seeks target returns of 9.5% to 20% per annum, with a median figure of 14%.
Dislocated Entry - Real Assets focuses on acquiring property, infrastructure, aircraft and similar investments, or the underlying debt, at a discount to true value, whether the stress arises from the asset itself or financing problems, but comes with a higher risk of cost leakage, particularly in real estate, and could also pose ESG concerns for investors due to the method of acquisition.
Net of fees, it seeks target returns of 9% to 18.5% per annum, with a median figure of 13.5%.
Dislocated Entry - Public Markets targets normally liquid credit instruments trading at a significant discount to provide a higher expected yield, with many managers focusing on a single sector and some broadening the spectrum as far as equities, but investors must consider the difference between theoretical and actual liquidity in this subcategory.
Net of fees, it seeks target returns of 8% to 20% per annum, with a median figure of 15%.