Part of our article Deep Value Investing: Your Ultimate Guide delves into the world of distressed debt funds, where fortunes can be made or lost on the turn of a company’s fate. But, how do distressed funds actually make money? What strategies do these investors use to navigate the complex landscape of financially troubled companies?
How Do Distressed Debt Funds Make Money?
Distressed funds make money by purchasing the debt or equity of financially troubled companies at a discount and profit for the eventual recovery or restructuring of these companies. Our article How do distressed debt funds make money? will examine the distressed debt fund process of purchasing debt at a discount, distressed companies' equity purchases, bankruptcy proceedings participation, debt or equity resale, legal strategies, and restructuring fees.
Our synopsis, How do distressed debt funds make money? can provide investors with a unique perspective on leveraging market inefficiencies. By grasping these strategies, you can diversify your investment approach and potentially uncover hidden value in distressed assets. Here are the ways distressed debt funds make money:
Debt Purchased at a Discount
Debt Acquisition – Distressed debt funds purchase the debt of troubled companies at a deep discount to the debt’s face value.
Restructuring – If the company recovers, the distressed fund may restructure the debt and receive its full-face value or negotiate an amount higher than the initial purchase price.
Debt-to-Equity Conversion – At times, distressed debt funds convert their debt holdings to equity, giving them an ownership stake in the company. Upon the firm’s recovery, their equity investment can be significantly more valuable.
Distressed Companies Equity Purchases
Equity Investment – Distressed funds may purchase shares in the challenged company at very low prices, betting on the firm’s recovery.
Active Involvement – With a distressed fund’s equity investment comes management and/or board representation. The funds usually take an active role in steering the troubled firm back to profitability. A successful company turnaround can increase the distressed fund’s equity considerably.
How do distressed debt funds make money? can empower investors to identify high-risk, high-reward opportunities that others might overlook. By learning the strategies used by these funds, investors can better navigate market downturns, capitalize on undervalued assets, and enhance their portfolio’s resilience during economic turbulence.
Bankruptcy Proceeds Participation
Investing in Bankruptcies – Investing in companies undergoing bankruptcy is a lucrative strategy of distressed debt funds. They purchase the debt or equity during the proceedings and may become a major creditor.
Liquidations – If the fallen firm is unsalvageable, the distressed fund will seek to liquidate the company through an asset sale and profit from the proceeds distributed to the fund as a secured creditor.
Debt or Equity Resale
Selling at a Profit – A company’s recovery or favorable market conditions can be catalysts for distressed debt funds to profitably sell their debt or equity at a premium to their initial purchase price.
Trading in the Secondary Market – Distressed funds can profit off the optimism of other investors and sell their debt or equity in the secondary market. The funds profit when the value of their holdings rises above their initial investment price, allowing them to sell at a gain.
Legal Strategy Leveraging
Litigation - Distressed funds can wage litigation war. The fund may engage in legal strategies to enforce claims, such as pursuing legal claims against other creditors or forcing a company into bankruptcy. The funds profit from favorable settlement and judgment rulings.
Restructuring Fees
Advisory Compensation – Distressed debt funds may charge a fee for their participation in the restructuring process. Their paid services can include providing advisory guidance, company negotiations with creditors or creditor negotiations with the company and firm turnaround advisory services.
How do distressed debt funds make money? focusing on these fund’s aim to achieve high returns, although the investments are typically high-risk and require deep expertise in financial and legal matters.
