Overview of Special Sits

I thought it would be nice to have everything related to "Special Situations" (i.e., opportunistic investments) in a single post so people better understand what it's about. Here we go.
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What is Special Situations ("SS") Investments

Contrary to popular belief, SS is often mistaken for being synonymous with distressed investments. In reality, it encompasses any investment that doesn’t align with the traditional strategies of other funds. That said, its origins are deeply rooted in credit and distressed scenarios (so there’s a valid reason why discussions about the two often overlap).

In practice, on the private market side, each fund has a defined investment strategy that it cannot deviate from, or LPs will be a bit pissed off. To accommodate flexibility, a new fund is often raised under labels such as: Tactical, Hybrid, Opportunities, Special Opportunities, or similar. Here are some examples:

• Morgan Stanley Tactical Value
• GS West Street Strategic Solutions
• Blackstone Tactical Opportunities
• Apollo Hybrid Vale
• KKR Dislocation Opportunities
• Ares Opportunistic Fund

These funds often allow broad discretion in investments. Their documentation may contain general phrasing such as "the fund pursues investments in special situations" (which LPs interpret as nearly full discretion) or provide examples like: "the fund will invest in companies affected by events such as divestitures, spin-offs, distressed situations, etc." Another typical but vague wording might state: "the fund will invest in opportunities with asymmetric risk-reward profiles."

On the public market side, hedge funds focusing on SS are less descriptively labeled. Some reputable names include Fortress Investment Group, Castlelake, and others (here is a good list: wallstreetoasisDotcom/forum/hedge-fund/breaking-down-distressed-funds-by-strategy).

Law firms also have dedicated SS teams to cater to such clients, often overlapping with their restructuring practices. Top firms include Latham & Watkins, Kirkland & Ellis, and Simpson Thacher & Bartlett LLP. These firms view SS as encompassing:

• Creative capital
• Restructuring
• Liquidity solutions
• DIP (Debtor-in-Possession) and Exit Financing
• Mezzanine financing
• Other aspects of debt or structured equity (refer to their websites for specifics).

What situations may fall under SS

Since these funds have broad investment mandates, their primary limitation is avoiding overlap with the strategies of other funds managed by the same GP, such as PE, Credit, or Real Estate. Common examples of potential SS investments include:

1. Growth Capital for SMEs: Late-stage funding; minority or majority investments.

2. Distressed Investments: Reorganizations, bankruptcies, distress-to-own strategies, broken balance sheets, or opportunistic buyouts involving operational challenges.

3. Opportunistic Event-Driven Financing: Funding tied to corporate events like M&A, divestitures, capital structure arbitrage, or complex carve-outs.

4. Non-Performing Loan Purchases: Acquiring loans at a discount, collateral analysis, and asset-backed securities.

5. Complex Secondaries Investments: Including pools of assets.

6. NAV Lending (self-explanatory).

7. Portfolio Purchases: Acquiring portfolios of assets (e.g., loans, real estate, or similar).

8. IP & Royalties: Investing in intangible assets.

9. Structured Capital

Examples: Mezzanine financing, convertibles, structured equity, etc. (though some funds have separate mezzanine-focused strategies funds or the credit fund also does them).

As you likely know, mezzanine instruments are hybrids, combining features of both debt (fixed payments and priority in bankruptcy) and equity (upside potential through mechanisms like convertibles, preferred shares, and similar structures). The better you can limit downside risk and capture upside potential, the more attractive these investments become and the more you may be invested in mezzanine than in other investments such as those mentioned above. For example, Bain Capital SS is now focused on mezzanine while having only around 15% of their total investments in distressed assets. This isn’t because they’re specifically biased toward either; it’s simply a strategic adjustment based on market conditions. At present, there are relatively few defaults in high-yield instruments, resulting in limited opportunities for distressed investing which pushes you to look at other places for returns. This observation also underlines the flexible approach and the essence of SS: Investment strategies are tailored to align with market realities rather than rigidly adhering to predefined criteria and filtering companies based on it (hence why it's called "opportunistic"). 

10. Litigation Finance: Providing funding for legal cases in exchange for a portion of settlement proceeds.

However, understand that SS strategies are extremely different across funds, so do your research if you're eyeing a specific one.

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Investment Approach & Philosophy

Many of the strategies enumerated above feel similar to fundamental investing because they focus on finding value—whether that’s buying assets at a discount or investing in situations where you have a strong understanding of the business or the unique circumstances it’s facing. The goal is to identify opportunities where the asset’s value isn’t fully recognized, often due to an added layer of complexity. This insight allows you to negotiate more favorable terms, whether that’s on the price, the deal structure, or both. 

Additionally, negotiation plays a key role in these strategies. With a flexible mandate, you have multiple ways to structure a deal, so your ability to work with management or other stakeholders is critical to maximizing (i) upside potential and (ii) securing favorable deal terms. Sometimes, you might start by identifying an interesting company and, through discussions, figure out how best to position yourself in its capital structure. Other times, you might already have a clear idea of what you’re willing to pay or the conditions under which you’d invest. In these cases, the willingness of the counterparty, seller, or other investors to align with your terms will heavily influence whether the deal moves forward. The tone of negotiations can also differ depending on the situation. In distressed deals, it’s often more adversarial due to competing interests or urgency. On the other hand, in more collaborative cases, like NAV lending, the focus is typically on finding mutual value and aligning goals.

That said, not everything is so obvious in terms of fundamental investing. For example, investing in IP or royalties is a bit different. These are more niche plays that don’t attract as much competition, which helps avoid inflated valuations, but also requires different valuation approaches that don't fit traditional models. After all, almost any asset can be a good buy if the price is right. The challenge with niche assets is knowing how to value them properly, but if you can do that, they can offer some really attractive reward-to-risk opportunities without the fierce bidding wars you often see with more traditional investments.

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Necessary Expertise for SS

• Strong valuation skills across the capital structure, including for non-standard assets.
• Deep understanding of credit (ranking, subordination, covenants, etc.) and credit agreements.
• Expertise in deal structuring, covering financial and legal aspects (downside protection, exit strategies, asymmetric returns, etc.).
• Proficiency in distressed investing.
• Industry expertise, market analysis, accounting, and general skills typical of investment roles.
• Negotiation (more senior level).

These skills have different weights depending on the fund strategy and seniority level.

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Further (Relevant) Readings

• Moyer, Distressed Debt Analysis
• Gatto, The Investor's Guide to Credit Analysis
• Nesvold, The Art of Distressed M&A
• Kricheff, A Pragmatist's Guide to Leveraged Finance
• Rosenbaum, Investment Banking
• Lajoux, The Art of M&A

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I will elaborate on this post - especially on the 10 situations I pointed out (9th is done) - when I have more time, so feel free to save it.