The field of investing is very diversified and there are a lot of strategies that you can use in order to make your money work for you. Today we are going to discuss about distressed debt investing in order to help you understand how you can make money when various companies are having financial difficulties.
What is distressed debt investing
Distressed debt refers to all securities or bonds belonging to companies or other financial entities which are in default, under bankruptcy protection or are heading in that direction. In most situations bankruptcy means that all of a company’s securities are worthless. As a result they are traded with prices low below their intrinsic value. As you can imagine, investing in such securities comes with very high risks. However if the company does not go bankrupt and it manages to get back on its feat, investors who acquired distressed debt will make huge profits. The people who practice investing in distressed debt are usually large institutional investors. These investors are also called vulture funds and they have a lot of resources that help them calculate their risks and they can even influence a certain company’s financial future.
How to acquire distressed debt
There are three main ways through which investors can acquire distressed debt. The first way is through the bond market. This is the easiest way of acquiring default securities as the bond market has very good regulations regarding mutual funds holding. On that note, distressed securities can also be acquired directly from mutual funds. The good thing about this method is that the parties involved don’t have to worry if they transact large quantities of securities as the market won’t be affected and they won’t even be paying commissions. The third channel for distressed debt investing is the company in question. This means that the investor is working directly with the distressed company and it can help it extend its credit thus helping it get back on its feet.
Risk management for distressed debt investing
As we mentioned above, investing in distressed companies comes with a lot of risks which is why only large hedge or vulture funds can afford to try their luck with these companies. Risk management is very complex in these transactions. One of the main things that need to be considered is the possibility of deepening insolvency. For example certain actions can make the borrower become even more insolvent. Other similar examples are fraudulent prolongation of a company’s life by hiding its actual financial status or lost value that would have been possible if the company went bankrupt. Other risk management considerations are inter-creditor agreements, danger of litigation and reclassification of payments.