Mutual funds investing in distressed debt
In fact, fears of US stagflation have led to a massive sell-off in the global debt and equity markets in May and June , and markets still seem to be in a state of heightened volatility. As global economies begin to slow, the era of easy money will likely give way to further panic-selling and possible bankruptcies.
Defaults are also likely to increase after a three-year boom in bond issuance by borrowers rated at least seven levels below investment grade. In addition to such economic drivers, systemic factors such as the push from regulators and governments to clean up the accumulating non-performing loans NPLs on the balance sheet of banks are another key trigger. Basel II norms require that banks, with a larger appetite for risk, set aside more capital to meet unexpected losses and protect depositors and counterparties from on- and off-balance sheet risks.
This has resulted in stricter capital adequacy and provisioning requirements. A common solution includes the creation of asset management companies AMCs , which act as a centralised agency responsible for purchasing bad assets from the banks at a discount. The bad loans are centralised in a few hands, leaving the financial institutions with a cleaner balance sheet. The AMCs are thereafter able to pool together a portfolio of assets and sell to buyers willing to undertake the arduous recovery process.
Since default-rate statistics typically do not include the assets of the bad banks, true NPL levels are significantly higher than reported numbers. Return Profile of Distressed Debt Investing Shortly after the Asian financial crisis of , commercial banks, in a rush to shore up their balance sheet and raise liquidity, began selling both performing and non-performing assets at deep discounts to face value.
In normalised periods, defaulted assets are typically sold at prices that can deliver double-digit returns to the disciplined investor. However, this is not the case. Distressed debt investing can take several forms. The Asian Debt Fund focuses on individual assets. Pools of NPLs typically consist of corporate, retail and real-estate exposure, and require a time frame of years to resolve.
Individual assets afford the investor a greater level of control and typically require a time frame of under 18 months. With respect to the single-credit strategy, there are two types of investors: early stage and late stage. Early-stage investors normally purchase assets around the time of default.
Such investors create value by negotiating advantageous restructuring terms with the company. This investor frequently uses the legal system to enforce a desired restructuring. This investor waits for a restructuring plan to materialise, and subsequently invests at a discount to the perceived value of the restructuring plan.
The event-driven investor is typically passive. Distressed Debt Risks There are few investors who have the patience, relationships, expertise and information required to overcome the difficulties of investing in Asian distressed debt. For the event-driven investor, there are several risks to be addressed when investing in distressed debt situations: event risk, valuation risk, liquidity risk and legal risk.
The Asian Debt Fund has developed a unique approach to handling such risks. First, it is imperative to understand what a restructuring process truly is. Simply, it is a competition for value among all those who are owed money by the company that has defaulted on its debt obligations.
The manner in which this competition unfolds depends largely on the players and the country. However, for the purposes of this article, we will analyse it from a risk perspective. The first step in the restructuring process is negotiation, which can proceed quickly or slowly depending on the intentions of both the troubled company and the creditors.
Legal risk can play a significant role here. As such, The Asian Debt Fund is not involved at this stage. On average, negotiations take months, with most taking 18 months. A major contributor to the lengthy process is the banks themselves. Frequently incapable of absorbing the large haircuts to properly restructure a company, the banks delay the negotiation process.
As the regulatory environment changes, restructurings are expected to progress more efficiently. Nevertheless, such delays can be expected for the foreseeable future. While the laws may change from country to country, some principles apply universally, such as the concept of absolute priority of claims.
This means that secured debt instruments rank ahead of unsecured debt instruments, which in turn rank ahead of equity. To limit valuation risk, The Asian Debt Fund focuses predominantly on the most senior debt instruments in the capital structure. Normally, senior debt instruments are not affected by slight changes in valuation. Being able to identify opportunities that look promising is one of the key attributes for success in this space. What Should Investors Look For? When looking at a potential target for investments, a previously successful company that has run into hard times is a good opportunity.
There are two types of strategies when it comes to distressed debt investing. Both, of course, contain risks, but their potential for financial reward is certainly possible with both turnarounds and lend-to-own, although they are distinct types of investing that require different levels of commitment.
They are the following. Turnarounds: This is a strategy of buying low and hoping the stock rises. A turnaround is more of a quick course of action. Lend-to-own: This is a deeply involved process. Lend-to-own involves acquiring the secured debt of the distressed company, in tandem with a plan to convert the debt to equity — either consensually or by using a security enforcement or a formal insolvency procedure. How To Instigate the Distressed Investing Process Understand that investing in distressed debt is normally something not undertaken by individual investors, but rather by institutional investors, although there are mutual funds that invest in distressed debt or include it as part of a portfolio.
There are different types of debt-like securities, including bonds both public and private , term loans, preferred stock and convertible securities, which are similar to bonds, but give an option to be able to convert the debt into equity in the event that the stock price rises above the conversion price. There are three steps in the process to get the ball rolling. These are the following. Identify the target: Look for a company with debt trading at a larger discount than is justified, considering the potential for a turnaround.
With asian forex market assured, what
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With the credit crunch still bombarding the financial sector, inflation and strapped consumers squeezing profit margins and interest rates on the ascent, now would seem like a horrible time. But markets are notoriously early in anticipating recoveries, so maybe a turnaround is closer at hand than most investors suspect.
In fact, no one knows for sure. A prudent answer to the second problem -- which distressed assets to buy -- is, like with many investment decisions, diversify your holdings. One way to achieve diversity in this risky area is by buying shares in mutual funds that invest in distressed securities.
Many offer the added advantage, for those uncertain of timing, of " dollar cost averaging " programs where investments are spread out over time. Search this website How to Invest in Distressed Debt Distressed debt is a form of investment which often provides substantial returns. In this article, we look at how this tool works and the potential risks involved. Possessing wealth is not enough. You also need to invest it in a proper manner, if you wish to enjoy it for a longer period.
Most people go for some kind of investment to grow their money. People who are willing to take risks, put their hard-earned money at stake and invest in high-risk investment options like stocks, mutual funds, etc. Those who wish to play it safe, go for a fixed but low-return instrument like bank deposits.
No matter what investment option you choose, it is imperative that you think logically, before investing your money in it. You simply cannot afford to allow your investment to shrink due to volatility in the economy. Distressed debt is yet another investment option for the enterprising folks, who are willing to take risks.
How Does it Work? Distressed debt refers to the bonds of a company, which is not doing well financially. The company might have already filed for bankruptcy or could be heading towards one. When the company faces a financial crisis, it can choose to sell its bonds to new buyers, in order to attract capital.
Thus, it simply means investing in the bonds of a failing company. In such a scenario, the company usually sells its bonds at dirt cheap prices. This is often the last resort to recover from a financial turmoil. Mostly, these buyers are financial entities such as mutual funds, private equity firms, brokerage firms, hedge funds, and specialized debt funds.
These entities have their own criteria, which enables them to invest in the right companies.
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