Vultures are circling but they’re struggling to determine just how dead the economy is. Funds that invest in distressed debt are building up their war chests, but they don’t know whether they will be able to pounce soon or will have to wait.
This has been a slow year for vulture funds. As of mid-May, only four distressed debt funds had closedOpens a new window after collecting a meager $2.5 billion, compared with $33.1 billion in 2016 and a record  $44.7 billion in 2008.
What’s baffling the vultures is that even at 11 years — the longest economic expansion on record — it’s hard to know when to expect the market correction that opens opportunities to make money on distressed debt.
Early bird catches the worm?
If vulture funds are an early-warning sign of an impending recession, the uncertainty is good news for everyone else. It’s another element of the current economic conundrum — historically low unemployment and inflation and continued growth even in the face of uncertainty over global trade prospects.
The Federal Reserve said after its December meeting that it’s sufficiently confident in the economy not to plan interest rate adjustments throughout next year. Investors seem to agree and began moving out of safe havensOpens a new window into riskier investments after the Fed’s last rate cut in October.
There are some initial forays into fundraising for distressed debt, with commercial real estate one of the early targets. SKW Funding and Bain Capital Credit joined forces in JulyOpens a new window to invest in under- and non-performing notes, and will spend $500 million over the next few years. However, earlier efforts to anticipate stress in commercial real estate has left managers with money but few opportunities to spend it.
Keeping your powder dry
In other words, investor interest in what’s sometimes known as special situations tends to anticipate market opportunities. The lowest-rated junk bonds are showing signs of distress as yield spreads widen above those in the broader market. This is creating interest among fund managers but is hardly pronounced enough to be called a trend.
Part of the problem is that investors have already made substantial allocations to vulture funds but are still waiting for the money to be invested, creating what Prequin head of private debt Tom Carr calls a dry-powder phenomenon. He notes that uninvested funds have increased by 82% since 2013. “Investors may be waiting for managers to put some of their $87 billion in dry powder to work before committing further capital,†Carr said in May.
What this means, says Prequin, which tracks alternative investments, is that distressed debt has lagged other private debt funds, losing 1.16% over the first nine months of 2019 while mezzanine funds have returned 16.1% and direct lending 6.6%.
However, vulture fund firms are bulking up with staff and money. York Capital Management, Pimco, Angelo Gordon, CQS and Hayfin Capital Management are among managers fundraising for distressed debt or considering it. Investment strategist John Mauldin counsels patience: The collapse in the bond market is comingOpens a new window  in the near future, he says, presenting investors with an opportunity to acquire corporate bonds at a fraction of face value and make a handsome return.
He may be right but Mauldin’s forecast depends on what he means by the near future. Bruce Flatt, CEO of Brookfield Asset Management, said earlier this month that his half-trillion-dollar fundOpens a new window was ready to pounce when markets turn and make distressed debt highly attractive. But he, too, hedges on the timing, saying Brookfield will keep on investing normally if distressed debt opportunities don’t materialize soon.