When a company is going bankrupt, there are things they can sell other than its assets. For one, they can also sell their debt.
What is Distressed Debt?
Distressed debt refers to debt a company has when they are in financial distress. Financial distress could either mean default or bankruptcy.
Distressed debt poses as a high-risk investment because there is a great possibility that the company will not be able to recover. This is why limited investors are only allowed to invest in distressed debt and distressed assets. Usually, these investors come in the form of hedge funds.
Hedge Funds and Distressed Debt
A hedge fund is a limited partnership where investors focus on taking high-risk investments in the hopes of getting high returns. This is formed through pooled funds that are allocated to different investment strategies. Depending on the investment strategy of a hedge fund, its risk appetite will also vary.
One of the investments a lot of hedge funds get is distressed debt. Although it sounds unreasonable to invest in something with a high risk of losing value, hedge funds still get attracted to a lot of distressed debt. The reason is that the higher the risk you get yourself into, the higher the returns that you can possibly get. For example, a distressed debt will be sold at a discount from its par value. A hedge fund can buy these debts and when the distressed company becomes successful, the value of the debts will increase. This alone makes distressed debts attractive to investors.
There are many ways hedge funds can get access to distressed debt. One is from the bond market. The bond market is the easiest place to purchase distressed debt because the latter becomes available when a company files for bankruptcy. In this way, hedge funds can already get their investment as early as bankruptcy is evident.
Another way to get a hold of distressed debt is through the distressed company itself. Although this can seem the trickiest to do, this will allow the hedge fund to communicate directly with the company so they can extend a line of credit. Ideally, more than one hedge fund extends help to a firm so the risk evens out to everyone.
Hedge Funds Advantages and Disadvantages
The most obvious advantage of investing in distressed debt is the returns. In a short amount of time, hedge funds can receive a big gain on their investment. Whether the distressed firm is going through liquidation or reorganization, the investments will still yield high returns.
On the other hand, it can be difficult to know when the best time to buy distressed debt is. While it is relatively easier to know if a company is going bankrupt, the same cannot be said for the actual debt. To add to that, distressed companies also view this kind of investment in a bad light giving hedge funds a more difficult time to acquire them. This can lead to complex negotiations and losses for the hedge fund. Gelt Financial, LLC is a direct buyer of distressed debt!