The bonds purchased from a distressed company are considered distressed debt when the company is bankrupt or near bankruptcy. This is another real estate investing option you need to know when you’re planning on becoming an investor.
Generally, companies recover and resume business after experiencing adverse financial circumstances. They become distressed debt investments when they can’t recover from a severe recession.
Insufficient financial resources result in a substantial decrease in the value of financial instruments issued by the issuing company. In spite of this, distressed securities can be highly profitable for high-risk investors due to their inherent riskiness.
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What are Distressed Investments?
A distressed investment seeks debt securities that are trading at a discount—that is greater than they should be given a potential turnaround. To influence the reorganization process, investors acquire substantial stakes in debt tranches if they find a worthwhile opportunity.
There are many reasons why businesses have problems and a common example of this is debt. A company with a high level of leverage can easily go bankrupt if it fails to generate enough revenue.
Additionally, companies in cyclical industries experience problems from time to time. High-leveraged cyclical companies usually have nowhere to go by the time the cycle reverts, despite the fact that these problems are not permanent.
Why Invest in Distressed Debt?
As a result of purchasing a large portion of the distressed issuer’s securities, distressed debt firms become major creditors of the distressed issuer.
Reorganization terms can then be prescribed by them. Because distressed debt firms are entitled to repayment before equity holders in the case of liquidation, they might be able to recover the entire amount invested.
Stocks sell for a very low multiple of earnings or below book value when everyone’s looking for an escape hatch, and bonds do the same. In some cases, even if things don’t improve, you might profit at those low prices.
However, distressed stocks carry a higher level of risk than distressed senior debt.
What Does a Hedge Fund Do with Distressed Debt?
A small percentage of hedge funds’ portfolios is made up of distressed debt. There are also ones specializing in distressed debt, especially from distressed countries, called vulture funds.
The most common method hedge funds use to acquire distressed debt is through the use of derivatives. Firstly, there are bond markets.
There is an abundance of distressed debt immediately following a firm’s default, making this method the easiest. A distressed firm could also restructure its repayment terms—giving it more flexibility and freedom in dealing with its problems.
How Risky is Distressed Investing?
Generally, investors profit from trouble by fleeing when they detect uncertainty and sell at any price they can get. If you buy at low prices, you could potentially make money even if the company liquidates. However, liquidations are complicated legal processes in which you have very few chances of making money.
It increases the chances of payback, but priority doesn’t guarantee it. A minimal investment compared to the size of the company also mitigates the risk. These small investments offer high return potential and little overall risk, making them good investments for long-term success.
It is common for businesses to go bankrupt when their sales permanently decline, coupled with high levels of leverage. A healthy balance sheet, high liquidity, and a relatively stable business are what you want to look for in distressed businesses, which reduce bankruptcy risk.
Can Individuals Invest in Distressed Debt?
Aside from real estate investing, individual investors can also benefit from distressed debt investing for the same reasons, which makes it an excellent asset class for hedge funds.
Individual investors have several opportunities to invest in distressed debt, even though they may not play an active role in the restructuring.
It is crucial to determine how the distressed debt is procured after finding a good distressed debt candidate. The bond market can be used for this purpose, similar to how some hedge funds use it. It’s a much more viable option for individuals because of the smaller amounts.
Get More Information About Distress Investing from Saint Investment!
Investments in distressed debt are considered high-risk, high-reward investments—and those willing to take the risks can gain greatly.
A distressed company’s difficult economic times can yield fantastic returns by managing these risks—either by hedging or by doing significant research prior to investing in it.
Our knowledgeable team can provide you with more information on debt investing, commercial real estate investing, and other investment opportunities. If you have any questions, don’t hesitate to call us at 949-881-7128 at Saint Investment Group today!
President of Saint Investment Group
Nic is a two decade seasoned expert in investing and capital raising, specializing in Real Estate and debt markets. With Saint Investment Group, he leads large-scale distressed asset purchases and innovative syndications for investors.