Special Situations
To the extent that you've spent time in special situations investing or have a perspective on it, I'd love to hear your thinking on it. I've been in upper mid market private equity for a while, currently a principal in a zombie fund, and am thinking about moving into adjacent areas. As an outsider to special situations, here are some initial thoughts on it:
Pros:
(1) Less crowded than regular PE
(2) Feels like there's a lot of distress out there (i.e., potential for abundant opportunities?)
(3) It's an area where capital is more scarce
Cons:
(1) More adversarial and sharp-elbowed investing style
(2) Fewer firms to work for
Questions:
(1) Historical returns in this space (have heard mixed perspectives)
(2) Ability to transition from regular PE to special situations
Based on the most helpful WSO content, here’s a breakdown of insights into special situations investing, addressing your thoughts and questions:
Pros of Special Situations Investing
Cons of Special Situations Investing
Questions Addressed
Additional Insights
If you're considering a move into this space, it might be helpful to explore case studies or modeling tests specific to special situations to familiarize yourself with the nuances of these deals.
Sources: Distressed vs. Credit vs. Special Situation vs. Turnaround PE, Distressed vs. Credit vs. Special Situation vs. Turnaround PE, Distressed Investing: This Time It's Different, https://www.wallstreetoasis.com/forum/hedge-fund/the-future-of-special-situations-distressed?customgpt=1
(2) and (3) from your pros list are false. There is very little structurally this asset class has going for it - it's probably better than post-ZIRP PE but that's not saying much. There is not a significant amount of distress out there relative to the amount of capital/funds chasing that distress, and most of the distressed situations are distressed for a reason (i.e. uninvestable). There is a disproportionate amount of people in the industry relative to the amount there is to do because of the game theory / intellectual aspect of it which people find attractive but in general you are going to be investing across from the same crowd of sharp people who have done the same deep work on the same cohort of shitcos as you. You have to just do this because you like it and accept that it would be far easier to make money investing elsewhere.
It's hard to say across all of these. There are funds which make money and tons which don't. Make no mistake, there is a lot of capital in the special sits place and it's not easy to deploy. See recent FT article on Oaktree (Oaktree’s path puts private credit choices into relief). Critically in special sits, credit selection is very important so the risk of deploying for the sake of clipping the management fee on capital is very high. A lot of special sits funds have collapsed over the past ten years, the few which remain have also diversified into direct lending, CLOs, etc.
Each fund has its own alpha and specialisation. Sourcing a private deal isn't as straightforward as doing sponsor direct lending, similarly not all funds are well equipped to play around in public markets. Every fund has its own investment strategy / themes. It's true there is a lot of distress out there, but only a fraction of them are lucrative situations to provide new money or refinance the existing capital structure (unlike in e.g. restructuring IB where you can provide advice across a range of stressed situations)
It's true that special sits is less commoditised than PE. What that means is that you don't have giant teams in special sits like you would in MFPE. However, the PE experience is highly valuable in special sits because more often than not, you're taking up some form of equity-like risk, with the added benefit of credit structuring (to support you in a downside case). Some distressed funds prefer to hire PE guys for that reason, although you'd need to show that you can shift your view to look at things from a credit perspective (and also be able to objectively evaluate a non-performing company, which is rare for many PE analysts / assocs)
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