KKR resurrects credit fund with new name, strategy for virus era

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KKR & Co. is rebooting an unsuccessful credit fund with a new name for the coronavirus era.

The firm has rebranded the Special Situations Fund III as the Dislocation Opportunities Fund, refocused its strategy and swapped managers in the hope of raising new money to scoop up bonds and loans battered by the Covid-19 pandemic. Instead of just seeking out distressed situations, the fund has a wide mandate to buy corporate and asset-backed debt, according to a marketing document seen by Bloomberg.

KKR is marketing the vehicle to potential investors and plans to close the current round of fundraising on May 15. The firm is contributing $400 million of its own capital and seeking approval from clients to repurpose at least $217 million that was committed to the special situations fund, said a person familiar with the effort, asking not to be identified because the information is private.

A KKR spokeswoman declined to comment.

It’s a timely pivot. With the economic pain from the pandemic spreading, dozens of asset managers are racing to gather pools of money to capitalize on credit-market stress. Oaktree Capital Group, one of the oldest distressed-debt investors, is trying to raise a record $15 billion. Others include Oak Hill Advisors, Angelo Gordon and Fortress Investment Group.

The revival also may salvage an ill-fated strategy. When KKR went to market with its third special situations fund, most investors balked. The economy was buoyant, there was scant distress in credit beyond the retail and energy industries, and rival managers bemoaned a lack of targets.

Less Money
By June 2019, the firm had only $617 million of commitments, including money from its own balance sheet, the marketing materials show, after attracting $2 billion and $3.35 billion for its previous two special situations funds. Over the following eight months, the investing team led by Nat Zilkha, head of special situations, found little to buy and KKR halted fundraising, according to the person familiar with its efforts.

While New York-based KKR manages $40 billion in publicly traded credit, it has less experience in distressed debt and restructuring than rivals such as Oaktree, Apollo Global Management Inc., and Blackstone Group Inc.

Jamie Weinstein, who co-managed KKR’s last special situations fund with Zilkha, announced his resignation in January 2019. He joined Pacific Investment Management Co. in a similar role last September. And Mark Brown, KKR’s co-head of special situations in Europe, left the firm a few weeks ago.

The week of March 16 was a terrifying one on Wall Street. The S&P 500 plunged almost 15%, stock volatility surged to its highest since the financial crisis and high-yield bond spreads widened by the most ever.

That Friday, KKR’s credit team, headed by Todd Builione, realized that a historic buying opportunity had developed and the firm needed to mobilize capital, the person said. Raising a new fund could take months. Over the weekend, the group decided it would be faster and easier to repurpose an existing vehicle: the unsuccessful special situations fund.

Name Change
The pitch book prepared for investors details the name change, the $617 million of previously committed capital and the new strategy. The firm is specifically targeting three types of investments that emerged from the March selloff: high-quality corporate bonds and loans trading at discounts because of “forced selling,” companies hit by Covid-19 fallout, and debt backed by real estate or other assets.

As a dislocation opportunity fund, the rebranded vehicle will deploy capital over a “tight” 18-month period in pursuit of annualized returns of 15% to 20%, according to the marketing materials. Instead of Zilkha, Chris Sheldon, a 16-year KKR veteran and head of leveraged credit, is the portfolio manager.

Management fees start at 1% of assets, declining to 0.5% at more than $250 million, the document shows. KKR will keep 15% of profits in carried interest once the fund clears a return hurdle of 6%.

Since the beginning of March, KKR has invested $2.5 billion under Sheldon across its publicly traded credit businesses, Bloomberg reported last week. The Dislocation Opportunities Fund has deployed more than $200 million in “highly attractive credit assets,” a quarter of which was in sectors affected by the pandemic, according to the pitch book. That money was plowed mainly into first-lien debt at a weighted average price of 78 cents on the dollar.

It’s a competitive time to be raising money, and credit markets are rebounding with the help of government stimulus. The question now is whether KKR’s institutional clients -- the pension funds and endowments that are being wooed by so many other firms -- can move quickly enough to allocate money before the best buying opportunities are gone.

Bloomberg News