Investing in Distressed Securities
Investors seeking exposure to securities issued by companies in distress are typically seeking higher returns in exchange for the added risks. Success in distressed security investment requires unique skills, and typically investors participate via vehicles such as hedge funds or private equity funds. Hedge funds offer greater liquidity for the investor (and greater access to capital for the manager.) However, the illiquid nature of many distressed securities may confer advantages to the fixed term and closed-end structure of private equity funds.
There are a number of security types that relate to distressed companies:
- The publicly traded debt and equity
- Newly issued (orphan) equity of companies recently emerged from reorganization
- Bank debt and trade claims that the original creditor may wish to monetize
- “Lender of last resort” notes
Frequently investors use these securities in conjunction with a range of derivative products to hedge related risks.
The reasons distressed securities can offer high risk-adjusted returns relates to the market opportunity that arises because other investors are either unwilling or unable to participate in the market. Some funds are prohibited from owning speculative grade debt, and are forced to sell holdings that lose an investment grade rating regardless of price. Others do not wish to participate in drawn-out bankruptcy proceedings and will accept a fraction of the value of their claims in exchange for immediate cash. In other cases, failed leveraged buyouts or unduly shunned companies that recently emerged from bankruptcy may create a temporary imbalance of supply and demand for their securities.
For more information, see all articles on: Active Management, Alternative Assets, Investing in Distressed Securities, Investment Returns, Portfolio Management, Risk Management See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
