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Ropes & Gray: Credit managers turn to distressed debt

Thursday, May 24, 2018
Opalesque Industry Update - Intensifying market competition in an increasingly crowded space is the top concern among credit fund managers, according to a new report from global law firm Ropes & Gray.

The report, "Driving Success: Challenges and Opportunities in Credit Fund Platforms," analyzes the responses of 100 senior level executives within U.S- and U.K.-based credit funds. They were surveyed in the first quarter of 2018 by Debtwire on behalf of Ropes & Gray.

"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," stated Ropes & Gray private funds partner Jessica O'Mary. "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 survey revealed that 71% of respondents cited their biggest concern as competition, while 65% 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%, only 39% 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.

"While distressed debt is an existing flagship strategy for a number of funds due to the higher returns these loans offer, there are various indicators that a turn in the credit cycle may be on the horizon," outlined Ms. O'Mary. "Although the timing for the downturn is unclear, fund managers are already positioning themselves to take advantage of this opportunity to be able offer this type of credit-especially if the fundamentals of the borrower are sound."

"Working with managers that can offer multiple strategies is often attractive to investors with large amounts of capital to deploy," stated 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% of respondents using leverage for longer term investment purposes, and 37% doing so only for bridging liquidity. With 42% using season and sell as their fund structure, utilizing 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-U.S. investors who are often subject to US taxation on income from loan origination activities conducted in the U.S.

Managing conflicts is also a top priority for managers who oversee multiple funds and accounts investing alongside each other, with 63% operating between one to five separately managed accounts and 37% running over five, although the majority (58%) do not have walls in place to address issues related to material non-public information.

A full copy of the report can be accessed here.

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