Ares Management Launches $7 Billion Fund for Distressed Investments

Ares Management Launches $7 Billion Fund for Distressed Investments

Ares Management has announced the launch of its latest fund, Ares Special Opportunities Fund III, with a goal of raising $7 billion to invest in companies facing financial and operational challenges.¹ The initiation of this fund comes at a time when corporate stress is escalating due to a sluggish economy and high borrowing costs. The fund aims to tap into the increasing number of distressed investment opportunities arising from current market conditions.¹

Focus on Complex Situations

The fund plans to originate loans to private companies dealing with financial strains such as significant debt burdens or operational challenges like leadership changes and business model shifts.¹ It also intends to purchase public debt from companies experiencing financial hardship, engaging in distressed opportunities across both private and public markets.¹ This approach allows the fund to address a diverse range of investment opportunities presented by the current economic landscape.

By investing in companies that are fundamentally sound but facing temporary difficulties, the fund seeks to navigate the complexities of distressed investing. The strategy includes:¹

• Providing capital solutions to companies unable to access traditional financing;

• Participating in debt restructurings to assist companies in stabilizing their financial positions; and

• Investing across the capital structure, including senior secured loans, mezzanine debt, and equity stakes.

Context of Previous Funds

This new fund follows Ares Special Opportunities Fund II, which closed in October 2022 after raising $7.1 billion—exceeding its initial $4 billion target.¹ The interest in the previous fund indicates investor appetite for distressed investment strategies during uncertain economic times.

As of September 30, 2023, Fund II reported a net internal rate of return (IRR) of 4.82%, according to a presentation by Hamilton Lane for the City of Jacksonville Retirement System.¹ This performance reflects the challenges and opportunities inherent in distressed investing amid volatile market conditions.

Leadership and Organizational Structure

The special opportunities team is led by co-portfolio managers Aaron Rosen and Craig Snyder,  who bring experience in distressed investing and credit markets.¹ In February, the team was integrated into Ares' credit group to enhance collaboration and leverage the firm's resources in credit investments.¹ This organizational move is intended to streamline the approach to sourcing and managing investments within the firm.¹

Rising Defaults and Market Demand

The launch of the fund aligns with a notable increase in corporate defaults. The default rate for speculative-grade corporate borrowers rose to around 6% at the end of Q1 2023—the highest since the pandemic—according to a Moody's report.¹ This trend indicates a growing pool of distressed assets, presenting potential opportunities for investment funds specializing in this area.

Fundraising for credit special situations and distressed debt peaked in 2020 at $73.8 billion and has remained substantial, with 52 vehicles totaling $52.3 billion closed in 2023.¹ The sustained interest in these strategies underscores the demand for investment approaches that can navigate and potentially benefit from market dislocations.

Industry Trends and Competitive Landscape

Private equity firms have become increasingly involved in defaults, with approximately two-thirds of defaults between 2020 and 2024 linked to leveraged buyouts (LBOs) orchestrated by these firms.¹ Distressed exchanges are commonly used, allowing borrowers to restructure their debt without declaring a formal default, thus avoiding bankruptcy and enabling private equity owners to maintain their stakes. SOURCE

Other firms specializing in stressed and distressed debt are actively deploying capital. For example, Oaktree Capital Management has deployed more than half of its approximately $3 billion special situations fund, which closed in December 2022.¹ The fund focuses on middle-market companies experiencing financial stress.

These developments highlight a competitive environment where investment managers with expertise and capital are positioning themselves to take advantage of the increasing number of distressed opportunities.

Implications for Investors

The launch of Ares Special Opportunities Fund III reflects broader market trends and has several implications for investors:

• Access to Distressed Opportunities: Investors may gain exposure to distressed assets that could offer higher returns if companies recover.

• Portfolio Diversification: Investing in distressed debt and special situations can provide diversification, potentially performing differently from traditional equity and fixed-income investments.

• Market Timing: With corporate defaults on the rise and more companies facing financial difficulties, the timing may be significant for investing in distressed assets.

• Risk Considerations: Distressed investments carry higher risks, including potential defaults and restructurings. Investors should carefully assess their risk tolerance and conduct thorough due diligence.

Investors should consider if and how such strategies align with their investment objectives and the potential risks involved.

Conclusion

The initiation of Ares Management's third special opportunities fund occurs against a backdrop of increasing corporate distress and a challenging economic environment. By focusing on companies facing financial and operational challenges, the fund aims to engage with the complexities of distressed investing.

As the economic landscape evolves, funds specializing in distressed investments may play a significant role in providing capital solutions to companies in need, potentially influencing both the businesses involved and the investors participating in these strategies.

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1. _{PitchBook, Ares launches latest fund aimed at troubled companies, 2024.}

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