Alternative investment funds are piling into "special situations," which are undervalued corporate and sovereign debt in emerging markets, as global investment banks seek to lower their risk and meet regulations, according to Institutional Investor.

Take Oaktree Capital Management, for instance. It hired a distressed debt specialist to lead a group to focus on the area. Blackstone Group and Kohlberg Kravis Roberts & Co. are jumping into the field, and Fortress Investment Group, long involved the area, is creating even more special situation funds.

Special situations can cover a wide range of unpopular and often complex, sometimes somewhat exotic assets — anything from Argentinean sovereign debt to Spanish real estate, Institutional Investor reports.

Editor's Note: See the Disturbing Charts: 50% Unemployment, 90% Stock Market Crash, 100% Inflation

Investment pros see great promise in the niche, as they believe they can fill a void left by global investment banks, such as Goldman Sachs and Citigroup, which have less appetite for risk following regulatory reforms.

Special situations can be challenging. They require specialized expertise and determining the best price can be difficult. In addition, profit is far from assured, as prices might increase as more money chases deals.

Although Europe has plenty of distressed debt, banks there are reluctant to sell at low prices and create more balance-sheet problems. Instead, many investment funds are focusing on sovereign and corporate debt in emerging markets, the publication says.

"The market for corporate hard currency debt in emerging markets is fast approaching the size of the U.S. and European leveraged-debt markets," Julio Herrera, Oaktree's distressed debt specialist, tells Institutional Investor.

Issuance of corporate debt in emerging markets continues to surge, according to Fran Rodilosso, fixed-income portfolio manager at Market Vectors, and growing investor demand, low interest rates and improved access to global credit markets are driving the increase.

Emerging markets have already had a record year in terms of issuance of dollar-denominated corporate bonds, following seven years of steady growth, he says.

"A cursory look at the growing volume of new issuance might suggest a bubble could form in the asset class," Rodilosso notes.

However, less than $35 billion of the approximately $220 billion dollar-denominated debt issued in emerging markets issued so far this year is rated below investment grade.

Editor's Note: See the Disturbing Charts: 50% Unemployment, 90% Stock Market Crash, 100% Inflation