Investment managers see great promise in special situations for two main reasons. The first is the global economic meltdown and ongoing credit dislocation. The second is the predicament of global investment banks that once dominated special situations by sinking their proprietary capital into such deals.
Goldman Sachs Group’s special-situations unit, co-founded by Peter Briger Jr. and Edward Mule in the late 1990s, is the best-known example. Other players included Citigroup and Lehman Brothers Holdings. But diminished risk appetite and the wave of regulatory reform since 2008 are pushing banks out of special situations, regarded as part of the shadow banking industry. The result is a lending and investing void, at the precise moment when the sovereign and corporate distressed-credit markets are on fire.
Identifying a market opportunity is one thing; profiting from it is another. Given the idiosyncratic nature of special-situations investing and the potential for deals to go sideways, success doesn’t come easily. Pricing is a challenge. The key to investing in distressed assets is buying them at the right price relative to their risk profile. But with so much capital hunting for opportunities, prices will probably climb.
Because it’s tough to pull off, special-situations investing calls for the right blend of experience. Oaktree’s Herrera fits the bill. After earning a degree in economics, political science and Latin American studies from the University of California, Los Angeles, he began his career as a credit analyst and portfolio manager for RRK Capital Management. He went on to become a proprietary trader at ING Capital Holdings, where he specialized in Latin American distressed credit. He then headed emerging-markets corporate fixed-income research for Lehman before joining Fintech Advisory, a high-net-worth family office with a multibillion-dollar emerging-markets portfolio, in 1997. Based in New York, Herrera worked on some of the most compelling credit restructurings and other deals that came out of the credit crisis of the late 1990s and had a particular impact on Latin America, Russia and Asia.
Today, Herrera is largely concentrating on emerging markets such as Asia and Latin America. “The market for corporate hard currency debt in emerging markets is fast approaching the size of the U.S. and European leveraged-debt markets,” he says. “This growth has been driven largely by the easy availability of credit, relaxed underwriting standards and low levels of sovereign issuance, particularly in the wake of the 2008 financial crisis.” Corporate bonds now make up more than 70 percent of emerging-markets issuance, with total debt approaching $1 trillion.
In Europe, which investors hope will yield plenty of distressed-credit opportunities, banks hold many of the most coveted assets on their balance sheets. Although they need to reduce risk by unloading these assets, they have been unwilling to sell at low valuations because it would create more balance-sheet problems.
Andrew Tsai, CIO of New York–based multifamily office Chalkstream Capital Group, is skeptical about Europe. “We don’t think the opportunity is there yet,” says Tsai, who co-founded Chalkstream with former Morgan Stanley proprietary trading executive Peter Muller. There is also a “huge amount of capital that has been raised that is waiting on the sidelines,” he adds. At Institutional Investor and CNBC’s Delivering Alpha conference in July, Briger, now co-head of Fortress’s credit and special-opportunity business, expressed frustration about the prices at which European banks are willing to sell assets. (Mule, his former colleague, went on to found hedge fund firm Silver Point Capital, whose strategies include distressed investing.)
At Oaktree, Herrera says, emerging markets remain more appealing than Europe. But they aren’t for everyone, he notes: “Few dedicated emerging-markets investors have not only the scale but the long-term capital to be able to invest throughout a business cycle, especially during credit busts and market dislocation.” Along with a handful of other brand-name alternative-investment managers, Oaktree has the confidence to seal the deal.