Setting the context
This week, we will be going over a particularly interesting kind of Hedge Fund Strategy called Distressed Securities. Did you know institutions which invest in such companies are called “vultures”? You’ll find out why below 🙂
As the name suggests, distressed securities belong to firms that are “distressed”, that is, they have either filed for bankruptcy or are near the brink of it. Such firms, counterintuitively tend to attract certain investment management funds (generally Hedge Funds) to invest chunks of their money pie.
Well, given the obvious high risk these distressed firms hold, they trade at extremely depressed prices. This means, the Hedge Funds can swoop in and pick up such distressed securities at cut-throat cheap prices, in the hope that either:
I) The liquidation of the assets of the company would provide them with enough return versus the amount they deployed or…
II) They hope that the now distressed company is going to undergo some successful reorganisation and rise from the ashes like a Phoenix. Then, the Hedge Funds can happily source plump returns when things go back to normal.
In what form do Hedge Funds or Institutions invest in such Distressed Securities?
Well, this can be done in multiple ways. Either through lending a line of credit with customised contracts detailing the nuances of the payback or via pooling in with other investors to purchase bonds issued by the company or in form of preferred stocks.
More on the downside…
It must be noted that even though investing in Distressed Securities is extremely lucrative for Funds, it definitely is the poster-child of “high-risk, high-return”. In order to partake in such investments, not only do the investors require foresight into the possible events that may play out with respect to the company in the future, but also a high degree of expertise in bankruptcy regulations, legal proceedings and reorganisation strategies (hectic stuff!).
Distressed Security Investing is part of a larger cohort of Hedge Fund strategies called “Event-Driven” strategies. Event-Driven strategies as the name implies depend on predicting the outcome of various events like bankruptcies (discussed above), merger and arbitrages, company restructuring, etc. More on that later 🙂
Before we bid adieu, picture this, vultures circling around and swooping in on dead meat, care to connect the dots with the question this article started with?
That’s it for this week.
Coffee Time Finance ❤