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1.
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Definition
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Distressed securities are securities of companies or a nation's
central bank that are either already in default, under bankruptcy
protection, or in distress and heading toward such a condition. When
it comes to fixed income, these types of securities are below
investment grade, and can include corporate credit as well as
emerging market government fixed income. The most common distressed
securities are bonds and bank debt. While there is no precise
definition, fixed income instruments with a Yield to Maturity in
excess of 1000 basis points over the risk-free rate of return (e.g.
Treasuries) are commonly thought of as being distressed. A related
category is stressed debt yielding between 600-800 basis points over
Treasuries.
Historically, distressed securities have traded at deep discounts to
a rational assessment of their risk-adjusted value for a number of
reasons. For example, banks or institutional investors often have
constraints that prevent them from investing in such risky
securities. This has led to above average returns (adjusted for
risk) from investors in this asset class. In recent years, the
amount of capital devoted to the distressed securities sector has
increased.
Other Resources:
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APS Investment Services:
A security of
a company undergoing or expected to undergo bankruptcy or
restructuring in an effort to avoid insolvency.
More…
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Capital Market Risk
Advisors:
A security of a company undergoing or expected to undergo
bankruptcy or restructuring in an effort to avoid insolvency.
More…
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Candela Capital:
Companies that are usually going through bankruptcy or
reorganization. Managers buy these companies at bargain prices
and resell if the company recovers.
More…
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Advisor.ca:
Some managers will buy the debt and/or equity of a company in
bankruptcy or undergoing restructuring, usually at a deep
discount, betting on a turnaround.
More…
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2.
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Examples, Types, or
Variations
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Examples of
distressed securities include: bank loans, high yield bonds, busted
convertible bonds, trade claims held by suppliers, public and
private senior and junior debt, non-performing loans, distressed
real estate, and distressed equity securities.
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3.
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Formula
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Other Resources:
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Magnum:
A
distressed opportunity typically arises when a company, unable
to meet all its debts, files for Chapter 11 (reorganization) or
Chapter 7 (liquidation) bankruptcy.
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4.
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Related Terms
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Bottom Fisher
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Chapter 7
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Chapter 11
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Distressed Sale
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Securities
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Liquidation
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Event-Driven
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Reorganization
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Default
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Bankruptcy
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Trade Claim
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Default
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Junk
Bonds
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5.
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As
Used in the Hedge Fund World
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In the hedge fund
world, managers invest in the debt of companies that are are on the
cusp of bankruptcy. Managers can take either long or short positions
on these distressed securities; which can be purchased at greatly
discounted prices.
When
companies enter a period of financial distress, the original holders
often sell the debt or equity securities of the issuer to a new set
of buyers. In recent years, private investment partnerships such as
hedge funds have been the largest buyers of distressed securities.
Other buyers include brokerage firms, mutual funds, private equity
firms, and specialized debt funds (such as Collateralized Loan
Obligations) are also active buyers.
Other Resources:
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CIC Group, Inc.:
Distressed
Securities strategies invest in, and may sell short, the
securities of companies where the security’s price direction has
been, or is expected to be, affected by a distressed situation.
Hedge funds within this style may hedge with put options on the
underlying market.
More…
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6.
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Applications
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The most common
distressed securities strategy involves purchasing the securities of
a distressed company at a very discounted price, holding them while
the company restructures, then selling them after they have
appreciated.
Other Resources:
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EDHEC-Risk:
A
typical strategy consists of buying the distressed company’s
securities (from the senior secured debt to the ordinary shares)
at a discount price, holding them through the whole
restructuring process, and selling them after they have
appreciated again.
More…
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Magnum Funds:
The strategy is to capitalize on the knowledge, flexibility, and
patience that a distressed securities fund manager has that the
creditors of a company often do not have.
More…
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CIC Group, Inc.:
Distressed
Securities strategies invest in, and may sell short, the
securities of companies where the security’s price direction has
been, or is expected to be, affected by a distressed situation.
More…
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7.
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Misused
& Abused
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Other Resources:
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Agile Funds Group:
Risks due to
investing in distressed securities include legal difficulties
and negotiations with creditors and other claimants that are
common when dealing with distressed companies.
More…
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8.
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Additional Sources of Information
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Books
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News
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Scholarly Papers
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