Distressed Debt Market Sees Growth Spurt As Funds Flock To Yield

Pension fund and endowment investment in distressed debt in 2002 is far ahead of previous years as funds are placing money in one of the few areas offering attractive returns. In the first six months of this year, there have been eight completed searches resulting in 13 mandates, according to Loan Market Week andiisearches.com . By comparison, there were only two completed searches over the same period last year, and just nine searches completed in all of 2001. Furthermore, the distressed debt market should maintain its momentum in the second half of this year with three additional searches in progress and one more likely to begin shortly.

To be sure, one of the biggest drivers of the increase in distressed debt manager searches is the fact that there's more distressed debt than in previous years, thanks to record default rates. Indeed, there were only eight completed searches in total in the three years from 1998 to 2000. But one distressed debt manager said institutional investors are plowing money into the asset class now because there are not a lot of alternatives that can offer similar returns. "Other investments are showing negative returns or returns in the low single digits at best, while distressed debt investments offer a possible return of 15-35%," he said.

John Stark, principal at Water Tower Capital, thinks the increased interest in distressed debt is more than just a lack of other good investment opportunities. "Investing in distressed debt is the ultimate pure value play," he said. "If you want to invest in a company today, there is no more cost-effective way to get in than through the back door."

A large distressed debt manager emphasized, however, that experience is critical when dealing with such investments. "There are a lot of situations to look at, and mistakes will be made," he said. "But with the right manager, investors can earn attractive returns in this environment. It is a good sector to be in, if you know what you're doing." Indeed, it is a big reason why seasoned managers such as Angelo Gordon & Co, Credit Suisse First Boston and Oaktree Capital Management have been grabbing the lion's share of new distressed debt mandates over the last couple of years.

Another large distressed debt manager said the asset class is so attractive now because the available supply still dwarfs demand, thereby creating bargains and opportunities. But those opportunities won't last forever. "We are already passed the midpoint [of the latest wave], but we don't know what inning we're in," he said. "It could be the fifth, or it could be the eighth." He expects the supply to continue to be good for the next six months and diminish after that.

Stark is a bit more optimistic. "The default rate has not trailed off, and there is a big backlog of restructurings," he noted. As a result, he does not see much changing in the market over the next 12-18 months and predicts that a lot more money will pour into distressed debt.

The information included in the following chart represents new, potential, pending and completed search activity for the first six months of 2002 as compiled by iisearches.com. This information is derived from many sources and, while it is deemed to be reliable, cannot be guaranteed. To report search and hire activity, call Gar Chung at (212) 224-3936, email gchung@iinews.com or fax to (212) 224-3233.