Waiting for a Zoom meeting to start, a co-worker mentions an event-driven hedge fund and asks, what is a special situation fund? Here’s what you tell him …
What is a Special Situation Fund?
A special situation fund is an investment vehicle that pools investor capital and invests in potential growth opportunities resulting from event-driven corporate actions. These events include mergers, liquidations, acquisitions, distressed debt securities, spin-offs, and restructurings. Tell your inquisitive coworker the following:
Opportunity Identification – Financial analysts and data researchers identify special situations investments for the fund. Companies undergoing fiscal distress, or are embroiled in a complicated, adversarial transaction can be ripe for event-driven investors.
Due Diligence – The fund conducts a comprehensive due diligence assessment of the identified opportunity’s financial statements, management experience and expertise, market position and trends, and manageable risks.
Decision Process – What is a special situation fund? The decision process is the unique identifier of each fund. A risk/reward profile is generated and evaluated in relation to the fund’s investment criterion. If the investment team determines the opportunity is suitable, they develop an investment thesis detailing earnings projection, time horizons, position size, and expected return.
Strategy Execution – The strategies employed by special situations funds are as varied as the differing corporate events. The fund may be the white knight is a hostile takeover, invest in a bank liquidation, or provide mezzanine financing for a merger.
Management Participation – Taking an active managerial role in the firms they invest in is a fund stalwart. The management team may advise and participate in capital allocation decisions, restructuring and asset liquidation negotiations, and shareholder activism.
Managing Risk – Special situations investing is risky. Funds use geographic and industry diversification, short position hedging, and acute portfolio oversight as downside mitigation strategies.
Exit Strategy – Once the investment thesis’ desired return is achieved, the fund may choose to realize the profits by liquidating the position or asset. If the anticipated return is not generated during the determined time horizon due to a change in the firm’s underlying fundamentals, the position is sold at a loss and proceeds are funneled into more promising pursuits.
What is a special situation fund? The fund is a pool of event-driven investor capital earmarked for capital participation in special situations investment opportunities.
What are Examples of Special Situations?
Here are three examples of firms that have experienced special situations restructuring.
General Electric Company (GE) – The multinational conglomerate has undergone financial distress in recent years. Due to declining revenue and evaporating margins, special situations investors have targeted the firm’s distressed debt and securities in anticipation of a rebirth under new management.
Sears Holdings Corporation (SHLD.Q) – Sears, once the perennial retail giant, filed for bankruptcy in 2018. Event-driven investors purchased the ailing company’s distressed debt and equity looking for hidden value realized through restructuring or squeezed out of an asset liquidation.
T-Mobile US Inc. (TMUS) – The communications behemoth became a special situation play with its 2008 merger with Sprint Corporation. Investors invested in both firms to capture the pre-merger euphoric stock rise of the target firm, Sprint, and the historically documented parent company share decline of T-Mobile.
What is a special situation fund? A special situation fund is an investment that seeks above average returns by identifying and exploiting the mispricing discrepancies resulting from event-driven corporate actions.
Read next: How Do Special Situations Funds Work?
