Behind the 2020 trend: Private debt dislocation funds
2020 proved to be a mixed bag for the private markets in terms of fundraising. While some asset classes thrived, others struggled mightily to deal with the impact of the pandemic. Private equity and private debt both saw strong interest and commitment activity from pension plans while demand for real estate and real assets strategies flagged, all this according to new research from eVestment Private Markets.
Within private debt, so called dislocation funds saw a surge in interest as LPs looked for opportunistic investment opportunities.
What is a dislocation fund?
Broadly speaking, dislocation funds are credit funds that seek to generate returns by taking advantage of dislocations between the price of an asset and its intrinsic value caused by unforeseen or black swan events.
In a June 2020 investment recommendation for a dislocation fund, consultant Meketa wrote:
The initial focus of the Fund is to participate in larger, more liquid corporate credit opportunities and event-driven investments as the dislocation has dramatically increased the opportunity set for these transactions. At this point in the cycle, transactions are expected to arise more from distressed sellers rather than distressed assets resulting in attractive relative pricing with downside protection with the returns generated as pricing moves back towards par.
Dislocation allocations
Apollo, KKR, Strategic Value Partners, and Varde were among the firms launching dislocation funds in 2020. The consultant recommendations and investment memoranda for these commitments offer insight into what drove LPs to these funds. One theme that stood out across most of the documents was the emphasis placed on the deep experience and platforms that supported these funds.
While commitments to new strategies sometimes take many months to execute, consultants and investors appeared to be much more comfortable committing to dislocation strategies in short-order because of the extensive track records and credit focused resources available to these established fund managers. This is illustrated by the investment recommendation by consultant RVK for North Dakota Land Board’s $100 million commitment to Varde Dislocation Fund:
The Värde Dislocation Fund (the “Fund”) is a dislocation and distressed debt fund that seeks to invest across several phases of the current credit cycle…This Fund is supported by a strong investment team, with over 90 experienced investment professionals across 13 global offices… This Fund is Värde’s first dedicated dislocation and distressed debt fund, though the Firm has been investing in dislocated credit and distressed debt in some capacity since its founding in 1993… Overall, RVK believes that the Värde Dislocation Fund is a compelling investment opportunity due to its strong investment team, ability to pivot opportunistically across distressed asset classes, and conservative portfolio construction.
Additionally, the short time horizons of these funds were noted regularly. With fund lifecycles falling in the 5-7 year range, with most putting capital to work quickly, about a 1.5 year investment period on average.
“Go with what you know”
Smaller managers might be tempted to tap into this demand by launching similar strategies, but anecdotal evidence suggest that they reconsider these plans. Allocators who viewed dislocation funds offered by larger managers favorably are not likely to share that view on similar funds launched by smaller shops. Pension plan investors wanted their GPs to focus on their core areas of expertise.
As consultant NEPC notes in their Private Credit Thoughts & Actions:
“Seek managers with demonstrated industry expertise or other value-add capabilities to capture more consistent and reliable returns.”
LPs will more likely than not view a newly pitched credit strategy from a fund manager with one core fund strategy as a money grab rather than a compelling investment opportunity. This is especially true if a fund manager’s team did not grow in lock step with the additional strategy. Robbie Young, Investment Director at Aberdeen Standard expressed these sentiments in a conversation with eVestment Private Markets centered around the digital due diligence process in the wake of the pandemic (24:48 of video).
What’s more when moving to digital due diligence, pension plans opted to commit to managers and strategies that they had worked with previously. Few felt comfortable with starting new relationships in the year and many new commitment conversations were tabled.
For example, New York State Common Retirement Fund, who made 27 private equity commitments in 2020. Only three of those commitments were new relationships for the pension plan and the total value of those commitments was under $50 million total.
Moving into 2021, with perhaps more certainty in the market and “post-pandemic” on the horizon, it will be interesting to see how market dislocation funds raised in the wake of the pandemic perform and whether allocators made the right decision to pour in for opportunistic wins. Through Market Lens, clients of eVestment will have the most up to date insights from pension plans and consultants on their views on fund strategies across the private markets.
