BY NEIL UNMACK

Vulture funds will need to stretch their wings. Corporate defaults are falling, despite the surprising endurance of the pandemic. Investors that specialise in buying distressed debt like Oaktree Capital Management will have to look beyond the mainstay of public debt markets. 

The last two decades have been a golden era for financial crises, yet life is getting harder for funds who take control of troubled companies by buying their bonds or loans. Covid-19 did trigger some big failures, like rental car company Hertz. But default rates, which reached nearly 14% in 2009, peaked at around half that level in 2021, Moody’s Investors Service data shows.  

It’s part of a longer-term trend. High government debt levels mean central banks need to keep interest rates low, helping even shaky companies raise funds. Barring severe shutdowns from new coronavirus variants, 2022 may be even more stress-free. The proportion of U.S. loans trading below 80% of face value, an indicator of likely default, was just 1.12% in November, according to an index tracked by Leveraged Commentary & Data.  

Yet the business of managing distressed debt funds is far from dead. The sector raised some $40 billion of capital in the first 11 months of 2021, Preqin reckons. That’s on top of the $100 billion of so-called dry powder that was waiting to be deployed earlier in 2021. Oaktree, founded a quarter century ago by Howard Marks, just raised $16 billion for a credit opportunities fund.  

The Chinese property crash could be an opportunity. Dollar-denominated high-yield bonds from the country yielded nearly 25% in early December, according to an ICE Bank of America Asia index. And managers will also need to seek out higher returns by lending in the $1 trillion private credit market, where loans aren’t widely traded.  

New markets bring fresh challenges. Valuing Chinese debt is tricky given uncertainty over how offshore creditors will be treated. And returns in private debt may shrink as more money pours in. Experienced managers may still thrive.

But distressed debt funds on aggregate generated a 13% return in the 12 months after Covid emerged, according to Preqin, less than half the return after the 2008 crisis. With 2022 looking leaner, investors in vulture funds may find future pickings equally hard to come by.

First published December 2021