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Don’t Try to Raise a Distressed Debt Fund Right Now
Inflows have dried up at a surprising time.
The distressed debt industry is on track for its worst fundraising year since 2009.
Only four distressed debt funds had closed as of mid-May, having raised just $2.5 billion, according to alternatives data firm Preqin. The slow start to 2019 follows two years of declining investor commitments to distressed debt funds, which began to fall out of favor in 2017 even as overall private debt fundraising reached record heights.
The apparent lack of interest surprised Tom Carr, Preqin’s head of private debt, since the majority of investors surveyed by Preqin believe the market is at a peak. The last market peak was a boon for distressed debt funds, which raised a record $44.7 billion in 2008.
But fundraising plummeted after those massive inflows, with just nine funds closing in 2009 with only $7.6 billion in commitments.
Since then, the closest distressed debt funds have gotten to that 2008 all-time high fundraising total was in 2016, when 23 funds closed with $33.1 billion in commitments.
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“Given that many investors feel we are late in the market cycle, we might expect to see increased interest in distressed debt funds,” Carr said in a statement. “Those vehicles managed to capitalize on the previous major market correction, but investors do not yet seem to be flocking to them in this cycle.”
Carr suggested that the decline in fundraising may, in part, be attributable to the increased popularity of direct lending funds, which were a “nascent industry” in 2008. Investors surveyed by Preqin in September said they viewed direct lending and special situations funds as the most attractive private debt strategies, with distressed debt ranking as the third-most attractive.
Dry powder build-up could also help explain why investors have paused new allocations to the industry: uninvested capital has grown by 82 percent since 2013, even as total assets under management have only increased by 19 percent.Im
“Investors may be waiting for managers to put some of their $87 billion in dry powder to work before committing further capital,” Carr said.