The history of economic and financial crises has seen the emergence of investment funds applying so-called "special situations" or "distressed" strategies to replace the traditional financing methods of banks, which were seized up at the time: explanations and debates on this strategy, which is largely unknown and sometimes perceived as the "Dark Knight" of investment strategies.

Why is this strategy useful for the financial system?

This investment strategy consists of identifying companies which are suffering from a liquidity crisis in order to invest in the form of debt, or even to buy debt at a low price from debtors which are in default or close to bankruptcy, before restructuring it. During the sub-prime crisis, for example, distressed funds were the only players to provide liquidity by acquiring assets qualified as "toxic" and which financial institutions wanted to dispose of in order to improve their prudential ratios.

Unlike traditional funds, such as venture capital or buyout funds, whose performance is positively correlated to economic growth, this strategy has performed best during periods of economic downturn and restricted access to credit.

Absolute return and diversification in strategic asset allocation for investors are not the only advantages. By providing liquidity in constrained economic cycles, turnaround strategies can, over the long term, safeguard value in the companies in which the funds invest and avoid bankruptcy and the social consequences that follow.

Will history repeat?

Since their emergence in the 1980s, there have been two major events that have led to a significant increase in the number of opportunistic debt funds: the internet bubble crisis of the 2000s and the banking crisis of 2008, during which the amounts raised by this type of fund broke records, representing 8% and 10% of global fundraising respectively, according to a study carried out by Preqin for the venture capital industry.

In July 2020, at the height of the pandemic, the European Union announced a vast European aid plan of more than 3 billion euros for economic recovery. The multiplication of the confinements and the difficult recovery for some sectors of the economy finally pushed the European Commission to release 3,000 billion euros of state aid since the beginning of the pandemic. This aid has taken the form of concrete measures such as short-time working, state-guaranteed loans and the creation of solidarity funds. They have provided a breath of fresh air to several sectors such as the airline industry. As Margrethe Vestager, Commissioner for Competition, said: "Without exceptional public aid, otherwise viable companies would not have survived.

However, she recently announced the end of unlimited public aid by the European Union from mid-2022. The end of "whatever it takes" could therefore be a sign of increased difficulties for companies that are still facing liquidity problems, for which the activity has not fully recovered or which have not succeeded in pivoting their activity according to new consumer habits.

Are distressed funds prepared to step in?

Many turnaround funds have been formed in 2021, even exceeding their fundraising targets. Investors therefore do not seem to have been chilled by the financial support provided by governments to counter the economic slowdown, and managers who benefit from the experience acquired during previous crises seem ready to take the necessary risks. The main thesis seems to be that some companies, whose activity is maintained thanks to aid, will eventually default before turning to market players who will be likely to support them financially, before being restructured.