David Taylor joins host Joel Simon for a discussion of opportunity and activist funds, and choices for investors to deploy capital, including acquiring midstream and upstream energy assets.

(Editor’s note: transcript edited for clarity.)

Welcome to Pillsbury’s Industry Insights podcast where we discuss current legal and practical issues in finance and related sectors. I’m Joel Simon, a finance partner at the international law firm of Pillsbury Winthrop Shaw Pittman. We hope from wherever you are listening, you are safe and healthy. Today, I’m pleased to be joined by David Taylor, from Pillsbury’s corporate practice. Dave advises clients that are registered and exempt reporting investment advisors, broker dealers, domestic and offshore private investment funds and private equity vehicles on regulatory and general corporate matters, as well as other investors in a variety of transactional matters.

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Joel Simon: Welcome, Dave. I was hoping you could shed some light on what’s happening in the fund’s world. On the one hand, it seems that deal flow has slowed, but at the same time, funds keep raising money and the store of dry power keeps getting bigger and bigger. Given all the distress out there, there must be lots of choices for patient investors to deploy capital these days.

David Taylor: That’s exactly right. Many industry observers think there is a lot of dry powder sitting on the sidelines waiting to see what’s going to happen next. I sit in the Houston office, and when you sit in Houston, whether you do it on purpose or not, you end up learning and observing the energy world, so those are the kind of funds that I’ve probably seen the most of here recently. There are a lot of opportunities out there that we think are coming down the pike. In particular, if history is any guide, then we are probably going to see a lot of opportunistic fund activity acquiring what we call hotstream energy assets. Without going too far afield here, in the energy space, there’s upstream, midstream and downstream assets. Upstream assets are those assets that you use to drill a hole in the ground. Midstream is the stuff that gets the oil or the gas from the well to the refinery, and downstream is the refinery. Every time you see some kind of an oil crash or some kind of an energy crash, which you’re kind of seeing at the same time, you tend to see an uptick in activity of opportunistic funds chasing assets that are related to that space. If I had to predict, that’s what I see coming down the pike in the energy space in terms of funds.

Simon: Could you also tell us a little bit about some other types of funds? For example, what can you tell us about opportunity funds which I know thrive on volatility and juxtapose that with the volatility strategy funds which try to smooth out the highs and lows?

Taylor: I’ll answer the second question first. Whenever you see volatile markets—markets where there are a lot of highs and a lot of lows—you see investors start chasing consistent returns. They’re trying to round the edges off the volatile market, and those are volatility strategies. Volatility strategies tend to involve using either derivatives or some kind of a hedging mechanism, and it involves a couple of different assumptions. One of them is a long-term assumption about the value of the asset—typically a stock—but another one involves a long-term assumption about the yield curve when it comes to interest rates or some other issue that tends to contribute to volatility. So, while you might be taking a long position, you will go short sufficient to hedge the risk that might be related to the volatility of the asset. Right now, we’re seeing asset managers—in fact, I’m working with asset managers who are kind of reinventing themselves in the volatility space. It’s got its own issues. A continuously upward trending market tends to see lower returns if you’re employing the volatility strategy. With that said, that’s exactly what some investors are looking for right now, so managers operating in that space are getting a little traction.

At to your other question about opportunistic funds. Opportunistic funds are some of those funds—I’ll use a negative terms but I don’t mean it negatively—sometimes people derisively will call them vulture funds, but they aren’t necessarily negatively spaced vulture funds. They are funds that have capital and are looking for assets. That might be distressed assets. That might be the only market for those assets right now. I use the upstream assets as an example for that. But those assets can kind of get cleaned up and redeployed with clean capital or clean balance sheets if the acquired entities are redeployed in a good space. There are investment strategies that opportunistic funds tend to use when it comes to both the terms of the funds and the regulatory requirements. If you were thinking about investing in an opportunistic fund or you’re thinking about setting one up, there are a few quirks regulatorily speaking that you probably should keep an eye on right now. But that space is going to be pretty active we believe in the next six months to a year.

Simon: I know one other type of fund that’s also interesting in the current environment but might not immediately come to people’s minds is Activist Funds. They are stereotypically disruptive of public companies or they have a political or cultural agenda, but I’ve heard that in uncertain times, they can also be an alternate source of funding or liquidity. Almost like a White Knight to a company that could otherwise be in trouble.

Taylor: That’s a very good point, and White Knight is exactly the term. If you are a troubled fund and you’re looking for capital, a lot of Activist funds are looking at this as a good time. If you use the 2008-2009 Great Recession as a guide point, we would expect to see an uptick in Activist fund activity in the next year or two. Those were the high points after the crash. Activist funds stepped in, picked up distressed assets and used that as an opportunity to try to push their agenda with either public companies or private investment vehicles, and those agendas could be everything from good governance or a change in governance to social justice or climate change or labor relations—any of the things that you might see activists investors go to work on. Now there is an element here that is unprecedented. I can’t say the last time that we really had fund activity after a pandemic, but there’s a lot of discussion out there about Activist funds and if history will be any guide, I’ll bet you see some pretty good headlines about Activist funds in the next year or two. Companies that are looking for capital should not necessarily turn their nose up at Activist capital. They just need to understand that it’s going come with a price, and for companies that are open to change, there’s probably an opportunity for them there.

Simon: Thanks for that tour through the world of different funds. Anything to note on the regulatory front or is it pretty much business as usual for funds in that area?

Taylor: I don’t know if I’d call it business as usual, but the regulators have certainly been active in this time period. It’s sort of the definition of esoteric, but it’s been interesting to me how people have coped with electronic execution of documents. The SEC has some pretty tight guidance on what constitutes electronic delivery of everything from statements to investment acknowledgments, and so it’s worth digging in with your counselor, your advisor, if you’re considering that kind of thing. It’s just important to know so many people are dealing with it right now, and folks who I never would have imagined would be open to electronic signature or electronic execution are having to work through the issue, so if you find yourself either as an investor or a promoter considering the issues that COVID-19 causes when it comes to electronic execution, you’re not the only one.  Reach out to your counsel and work through it. There’s a little more flexibility right now than there probably historically has been.

Simon: Thanks for that Dave and for giving us some insight into what looks like to be a growing market for opportunistic investment in the current environment in the months ahead.