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Fixed Income

Where the Dry Powder Goes Next

May 2019 - 4 min read

Stuart Mathieson and Bryan High, portfolio managers for the Global Special Situations strategy, discuss the outlook for distressed debt investing—and explain how they’re finding opportunities throughout the cycle.

Recently, we’ve seen leverage levels for high yield corporate issuers creeping up on both sides of the Atlantic. Does this create opportunities for you?

The large inflows of capital into high yield markets have certainly allowed companies and private equity sponsors to structure more aggressive transactions—which means there’s more single-B and triple-C debt available, in general. Although defaults have so far remained low, at some point they will inevitably increase. That said, we do not need a higher default rate to deploy capital efficiently. For our special situations strategy, we can typically deploy about 80% of our investors’ capital within two years, even among a benign default environment—which we attribute to our integrated model, the breadth of assets we cover, and our ability to size funds appropriately for the opportunity set. Additionally, in the U.S., sponsors are paying high multiples for assets because there’s so much capital to put to work and it’s a very competitive market. To then achieve good returns, private equity sponsors are pushing the envelope on leverage—which doesn’t provide much leeway if their plans fall through, but creates an opportunity for managers with the expertise to navigate stressed and distressed credits. In certain cases, we are able to help restructure a company to provide a stronger balance sheet, a new board, and a fresh management team, for example.

How common is it for you to become heavily involved in a deal, from an operational perspective?

While we are certainly not looking to take over and operate all of the companies in our special situations portfolios, we do have the ability to get more involved when the need arises. We find that it’s helpful to have a seat at the table when companies go through challenging situations, so we can help drive outcomes that are most beneficial for our investors.

What returns do you target?

In our special situations strategy, we target a net internal rate of return (IRR) in the mid-teens. To achieve that, we’re flexible and look to seek out the best relative opportunities across our target markets and strategies. If we can achieve a 15% IRR on a discounted debt instrument, we’re happy with that. We’re equally happy if we can target a 2x money multiple by investing in a good business with a bad balance sheet, and unlock value by providing capital to invest or taking control through a debt-to-equity conversion.

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