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Reproduced from Preqin Pro; Chart: Axios Visuals

Distressed hedge funds that raised record amounts of cash last year to invest in COVID-hit businesses are sitting on a mountain of cash and competing for crumbs to invest it in.

Why it matters: Government stimulus programs, and the Federal Reserve’s intervention in markets, caught many Wall Streeters by surprise last year with their magnitude. They effectively cut short the distress wave that these hedge funds have been waiting on for over a decade — leaving many now scrambling for what to do next.

How it works: Distressed funds, which mostly buy the loans and bonds of struggling companies at pennies on the dollar, hope to profit when the issuers default and can't pay their debt bills. Outside of industry-specific pockets like oil and gas or retail, this hasn't happened en mass since the financial crisis.

What they're saying: “In the short term, I worry about not having great things to buy,” Oaktree Capital Management's Howard Marks said at an event this week, Bloomberg reports.

By the numbers: Distressed funds prepped for a pandemic doomsday scenario by raising $46 billion in 2020, almost double the annual average of $24 billion over the prior nine years, according to Preqin.

  • The typical places to put all that cash did not offer the opportunity investors thought they would, leaving funds sitting on $81 billion in dry powder as of September 2020.
  • With nowhere to go, distressed funds returned negative 8% on average during 2020 through September, compared with an average annual return of 12% from 2001-2019, Preqin says.

There are few signs of this dynamic changing.

The portion of high yield bonds that trade at distressed levels is just 2.8%, from 35% a year ago. It's now at the lowest level since 2007, according to S&P Global Market Intelligence.

  • The leveraged loan distress ratio is 2.04%, from 31% last March.

Default rates tell a similar story.

  • Rolling 12-month loan defaults hit 2.6% in April, slipping below the historical average of 2.9%. That's down from its peak in September at 4.15%, according to S&P.
  • The U.S. high yield bond default rate has come off its 2020 high point of 9.7%, and now sits at 7.7%, according to BofA Global Research.

What’s next: A hunt for new opportunity. Some funds are turning to more esoteric assets like vendor or insurance claims, or even returning cash to investors, Bloomberg reports.

  • Many have stretched to non-distressed high yield bonds — where strong demand has pushed up prices of even the riskier, lower-rated bonds, says Gershon Distenfeld, co-head of fixed income at AllianceBernstein.
  • The bubble-like demand has caused the high yield index to hover at record tight levels in the low-4% area.

What to watch: The Fed and a rate hike.

  • “The Fed is a cycle killer,” says William Housey, senior fixed income portfolio manager at First Trust Advisors.

The bottom line: What is generally a good sign for the economy, is a distressed investor’s worst nightmare.

Go deeper

Hertz shareholders in line for $8 recovery under bankruptcy plan

Photo Illustration by Pavlo Gonchar/Getty Images

Hertz was the original meme stock we couldn’t make sense of. A Robinhood-fueled stock frenzy after the car rental giant's May 2020 bankruptcy filing spawned finger-wagging and ridicule — but it turns out the day traders were right.

What's new: Hertz's latest bankruptcy plan, in which Knighthead Capital Management and Certares Management will buy the company for $7.4 billion, calls for equity holders to receive about $8 per share, Bloomberg reported Wednesday.

Biden administration outlines goals to slow migration

Vice President Kamala Harris speaks during a press conference in Guatemala City on June 7. Photo: Jim Watson/AFP via Getty Images

Vice President Kamala Harris has big goals for improving conditions in Central America to help slow migration from the region toward the United States.

Driving the news: Senior administration officials unveiled five sweeping goals during a call on Wednesday: Bettering economic prospects; rooting out corruption; promoting human rights, labor rights, and a free press; preventing gang violence; and combating sexual, gender-based and domestic violence.

Bryan Walsh, author of Future
9 mins ago - Health

Testing our way around the Delta surge

Illustration: Aïda Amer/Axios

The recent surge of COVID-19 cases is strengthening the case for more frequent testing.

Why it matters: The more contagious Delta variant threatens the fuller reopening of offices and schools in the fall. But regular testing — especially with cheap and almost instantaneous tests — could help catch cases before they have a chance to spread.

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