Distressed Debt Securities
Hedge Funds investing in distressed securities, typically purchase debt, equity or trade claims (claims held by suppliers owed for goods or services they’ve provided) of companies facing financial distress or already in default. Due to the markets inability to truly value these securities and the inability of many institutional investors to own below grade investment securities, they can often be purchased at deep discounts. Another reason for the deep discounts is the desire of banks to remove bad loans from their books and use the cash for other interest paying investments. Banks, along with holders of trade claims, are not in the business of restructuring companies and the sooner that they are able to rid themselves of non performing assets, the sooner they can get back to concentrating on their core businesses.
Forms of distressed securities include high yield bonds, bank loans, busted convertible bonds, public and private senior and junior debt, distressed equity securities, distressed real estate and non-performing loans.
The general strategy for investing in distressed securities that many hedge funds use is to purchase the securities, hold them through the restructuring process and then sell them once they have appreciated. The success of the strategy is dependent on the ability to assess the probability that specific restructuring techniques will be successful in order to turn an under performing company around.
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