There was a time when distressed debt markets were known as “vulture markets”, bringing negative images and perception of investing within the asset class.
But after more than a few years of growth, these markets, with millions of dollars invested within them, and with those investments proving to be a viable model, that viewpoint has changed drastically.
Today, the distressed debt market has evolved to become a standalone sector on its own. If you are looking for information on how these markets work and how to benefit from them, then the following might be intriguing.
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How Do Distressed Debts Work?
Before you delve into understanding distressed debts markets, it is important to understand how distressed debts work, and what makes an asset class qualify as distressed debt.
Simply put, distressed debt refers to a company’s securities that are issued at a lower rate than its market value due to the issuing company going through financial or operational distress.
According to experts, a distressed security or distressed debt is often 80 percent lower than its par value. The security is valued so low because the company is heading towards a financial debacle or already going through bankruptcy, during which it could really need a helping hand.
Often issued in the form of bonds, distressed debt seems to be lucrative to investors due to their higher-yet-difficult-to-achieve profit margins.
If the issuing company does drive it out of difficult times and retain its old value again, those who have purchased distressed debt off of it could then sell it for an increased value. These high chances of profit make distressed debts such an interesting investment.
The Evolution of Distressed Debt Markets
Distressed debt markets started off as an undefined asset value, where those who were looking to invest in this sector were simply called “alternative investors.” But as time passed by, definitive terms evolved.
After growing from a $100 billion market in 1992 to a $500 billion sector in 2008 (estimated figures), distressed debt markets have evolved to become a major investment segment. Those investors who were once labeled as “alternative investors” are now referred to as “credit” or “event driven” strategic investors. These semantics give the market and its associated entities a more credible approach.
Usually, these strategic investors operate out of a hedge fund model. By making sure that the overall investment is diversified behind the scenes. They do not invest all of a single entity’s money into a single offering in distressed debt instruments.
This provides them with the chance to safeguard the investment amount from increased risks. Even if the distressed company goes under, these investors’ loss is not substantial..
Another way to protect the investment comes in the form of indentures that are drafted for these distressed debt instruments. From compliance towards covenants to being wary of risk management, these indentures or agreements work towards protecting the lender by limiting the actions of the borrower.
Distressed Debt Comes Through Different Mediums
Distressed debt could often be obtained via a variety of sources. The most common segments in where distressed debt markets are present include:
Issuing bonds as securities is the most apparent way for companies to obtain distressed debt. It is also the most common way for investors to find distressed debts.
This is also used by some companies, but not to the extent of bonds due to the restrictions that revolve this investment model.
Instead of sourcing out distressed debt through the bonds market or through mutual funds, investors or distressed firms directly reach out to one another to strike a deal.
It is important to know your distress debt markets so you are aware of how to navigate your way through them. Along with this, it is also advised that you practice vigilance towards the bonds or securities that you are investing in. Doing so makes sure that you are exposing yourself to minimal risk.
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