When companies are nearing or going through bankruptcy, the bonds they issued are likely to default. These kinds of securities, known as distressed debt, have attracted risk-taking institutional investors such as hedge funds. Alternative asset management company Oaktree Capital Management, for example, is known for investing in this asset class.
How could investors generate returns by investing in distressed debt? The underlying cause is that investors associate higher risks with higher potential return. Distressed debt is usually sold far below its par value. Once the companies emerge from bankruptcy, investors could sell the bonds at higher price and gain huge return.
“Our approach seeks to combine protection against loss, which generally comes from buying claims on assets at bargain prices, with the substantial gains achieved by returning companies to financial viability through restructuring,” Oaktree said on its website.
Distressed debt investing is also a type of value investing. Unlike classic value investors, distressed investors use debt instead of equity as instruments, seeking to invest in bonds that are sold below its intrinsic value.
By: Frances Yunfan Yue
Illustration By: Emil Litwiniec