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Credit fund managers turn to opportunities in distressed debt

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Intensifying market competition in an increasingly crowded space is the top concern among credit fund managers, according to new research from global law firm Ropes & Gray.

The report, ‘Driving Success: Challenges and Opportunities in Credit Fund Platforms’, analyses the responses of 100 senior level executives within US and UK-based credit funds, in the first quarter of 2018.  Key findings reveal that 71 per cent of respondents cited their biggest concern as competition, while 65 per cent stated they intend to launch funds focusing on distressed/stressed debt opportunities in the next 12 months. Although general credit opportunities are the flagship strategy of most respondents at 33 per cent, only 39 per cent will launch funds focusing on broad opportunities. Respondents were unanimous in stating their intent to diversify from their current investment strategies in the next year as a multi-strategy approach leads investors to cast a wide net for returns with different risk-reward profiles.
“As credit funds have grown into their own asset class, that in and of themselves are unique, the lending landscape has seen dramatic shifts and is increasingly diversified,” says Ropes & Gray private funds partner Jessica O’Mary (pictured). “While these remain an attractive investment opportunity, private credit facilities have expanded in size and complexity. With evolving global markets, tax structures, monetary policy and regulations, we felt this was the right time to take the pulse of the industry and hear directly from credit fund managers about their concerns and outlook for the sector. We’re delighted to publish these findings in our report.”
“The fact that two thirds of credit fund managers say they expect to launch a fund focused on distressed or stressed debt is a good indicator that they are expecting the credit fund cycle to turn, says Matthew Judd, co-head of Ropes & Gray’s private investment funds group. “Although the timing of any downturn and the specific triggers are as yet unknown, it appears that many fund managers are positioning themselves to be able to take advantage of the opportunities that will arise.”
“Working with managers that can offer multiple strategies is often attractive to investors with large amounts of capital to deploy,” says Alyson Gal, partner in Ropes & Gray’s finance, special situations and business restructuring practice groups. “When managers offer multiple pockets with different strategies, this provides large capital investors with the ability to have a manageable number of relationships, while also creating an appropriate investment mix with different return profiles.”
Fund manager views on leverage are undergoing transition, as demonstrated by 60 per cent of respondents using leverage for longer term investment purposes, and 37 per cent doing so only for bridging liquidity. With 42 per cent using season and sell as their fund structure, utilising this structure is being influenced by a desire for liquidity and the maturity of investment assets as managers and investors seek higher after-tax returns. A significant amount of credit fund structuring is designed to address challenges faced by non-US investors who are often subject to US taxation on income from loan origination activities conducted in the US.
Managing conflicts is also a top priority for managers who oversee multiple funds and accounts investing alongside each other, with 63 per cent operating between one to five separately managed accounts and 37 per cent running over five, although the majority (58 per cent) do not have walls in place to address issues related to material non-public information.

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