16 January 2019

Not for the faint of heart: Support for distressed debt strategies

By Jonathan Eldridge

Recently, we explored the explosive growth of private credit and the opportunity it presents for investors. A smaller, but growing, subset of the private credit market is distressed debt and credit investing. Distressed debt includes debt instruments trading at a steep discount to par value due to an extremely negative outlook, or even outright default, on the part of the borrower.

According to McKinsey Global Private Market Review 2018, "The rise and rise of private markets,” fundraising advanced by 10 percent in 2017, totaling more than $100 billion to invest in private debt [1]. Moreover, in accordance with the Alternative Credit Council’s “Financing the Economy 2017” report, US funds allocate nearly 19% of committed capital to distressed debt [2]. Considering this rapid acceleration in distressed debt investing, private markets appear to be an acceptable surrogate to banks, per McKinsey [1].

Investors with sufficient fortitude stand to make substantial gains by purchasing the debt of overleveraged companies, usually on the brink of bankruptcy, with the goal of taking a controlling ownership position in them. Furthermore, these investors are providing an opportunity for those borrowers that have limited access to bank loans [1]. Distressed debt fund managers then deploy experienced teams that take an active role in managing their portfolio companies back to health with the objective of restoring their valuations.

In this scenario, the investor typically takes ownership through a debt-equity swap structure, in which the company agrees with the lender – in this case, a distressed debt fund – to eliminate some or all of its debt in exchange for an ownership stake. The complexities of these investments can be an operational headache. Increasingly, firms are counting on SS&C Advent’s Geneva® platform to enable them to manage distressed debt portfolios and account accurately for debt-equity transactions in takeover situations. In fact, five of the top 10-debt fund closes thus far in 2018 involved Geneva clients.

 The risks of distressed debt investing are readily apparent, yet when the strategy succeeds, the rewards are phenomenal relative to market returns. Not to mention, given the potentially higher yield, LPs are increasingly attracted to these style investments [1]. With a technology platform that delivers the accuracy and transparency necessary for tracking and allocating complex portfolios and transactions, there is an alignment of interests achieved between investors and managers, to learn more about Geneva World Investor, contact us.

Sources:

[1] McKinsey & Company. The rise and rise of private markets McKinsey Global Private Market Review 2018.

[2] Alternative Credit Council 2017. Financing the Economy 2017: The role of private credit managers in supporting economic growth