Investing in Special Situations Using Emerging Managers

Investing in Special Situations Using Emerging Managers

Investing in emerging managers who focus on special situations presents a compelling opportunity for sophisticated investors seeking outsized returns. Special situations, or "special sits", refer to investment opportunities arising from specific events that can potentially create shareholder value. These events include mergers and acquisitions, corporate restructurings, bankruptcy proceedings, or significant corporate disruptions. These events' complexity and time sensitivity require a specialized skill set, making emerging managers with expertise in this arena particularly attractive.

The Advantage of Emerging Managers in Special Situations

Their typically smaller asset base allows emerging managers to move quickly and efficiently without the market impact larger institutions might face. Emerging managers in special sits can navigate these waters with a fresh perspective unconstrained by legacy positions or corporate bureaucracy. They can also make bold moves and concentrate their best ideas, which might be unfeasible for larger, more bureaucratic organizations with rigid investment mandates.

Investing in emerging managers specializing in special situations also involves unique challenges and considerations. Institutional investors and family offices must conduct thorough due diligence to assess the manager's expertise, strategy, and ability to execute in a highly specialized field.

Special Sits Encompasses Several Investment Strategies

Merger Arbitrage

One plain vanilla special situations strategy is merger arbitrage, which involves taking positions in companies subject to a merger or acquisition. Emerging managers with expertise in this area conduct a rigorous analysis of merger proposals to determine the likelihood of completion and the potential profit from the spread between the current market price and the acquisition price. 

Distressed Debt

Another special sits strategy is distressed debt investing. In this strategy, an emerging manager with a strong background in credit analysis and a nuanced understanding of bankruptcy processes may choose to invest in the debt of companies facing financial challenges. These managers can identify firms with underlying solid assets or business models likely to emerge from restructuring in a stronger position. For example, an emerging manager may invest in the bonds of a retailer undergoing Chapter 11 proceedings, anticipating that a successful reorganization will enhance the bonds' value.

Activist Investing

Activist investing is our favorite special sits strategy that involves purchasing significant stakes in undervalued companies and advocating for change to unlock shareholder value. Emerging managers with focused portfolios who can take sizeable positions in smaller companies may engage corporate management to instigate strategic initiatives such as divestitures, share buybacks, or operational improvements. For example, an emerging manager could build a significant position in a small, underperforming media company, encouraging it to monetize underutilized assets, reduce salaries, and return capital to shareholders.

Assessing Manager Expertise and Skin in the Game

Investors should evaluate the manager's analytical capabilities and understanding of the particular sits space. This includes assessing the team's experience, research process, and ability to identify value-creation catalysts. The idiosyncratic nature of special situations requires deep sector knowledge, legal acumen, and a keen understanding of corporate governance issues that can affect the investment outcome.

Our capital providers always request quarterly and annual letters, investment memos on prior special sits investments and any articles or blog posts the investment manager has authored. This information helps the capital provider to understand how the manager thinks ex-ante about intrinsic value, catalysts, and the sizing of the potential investment.

Another critical factor is an alignment of interests. Emerging managers should have significant skin in the game when investing in special situations, ensuring that their success is directly tied to the performance of their investments. A strong alignment can be a signal of confidence in the underwriting process and can mitigate agency risk.

Strategy Scalability and the Strength of the Network

When considering emerging managers for investment, it's also vital to look at the scalability of their strategy. While they may be able to navigate special sits effectively with a smaller asset base, it is essential to understand how their approach might change as assets under management (AUM) grow.

Investors should also pay attention to the importance of a strong network. Emerging managers with extensive industry contacts can often gain early insights into potential special situations and are better positioned to move swiftly when opportunities present themselves.

The Potential for Outsized Returns

Investing in emerging managers focusing on special situations can offer institutional investors the potential for outsized returns, though it comes with unique challenges. Success in this realm is predicated on rigorous manager selection, a deep understanding of the strategy employed, and carefully considering the risk management practices of the fund manager. 

Please apply here if you are a manager focused on special sits. Our seed transaction size can range from $5 million to $25 million. This investment can be structured as a one-time initial investment into a fund or as a separately-managed account. Seed investments can also be structured as a credit line for specific transactions or co-investments.