Handbook of Hedge Funds

10

Distressed Securities

Debt markets are always sowing the seeds of the next distressed cycle. The real question is when will it be time to harvest?

Some hedge funds eschew the popular wisdom of investing in blue chips companies. They prefer to focus on investment opportunities from the darkest side of financial markets, namely, the securities of companies in financial distress, default or bankruptcy. The role of these funds is often controversial, particularly for the public. Since they pick the bones of underperforming companies, they have gained the “vulture” sobriquet. Needless to say, the term is quite pejorative. Most people are still philosophically opposed to the idea that some investors may insert themselves into a distressed situation for profit while the firm’s original lenders and stockholders are being asked to make material financial sacrifices. Such hostility, however, underestimates the critical role that distressed securities funds may play in the restructuring process. After all, ugly though they may be to look at, vultures also need to be acknowledged for the useful purpose they serve as scavengers.

10.1 DISTRESSED SECURITIES MARKETS

10.1.1 The origins: railways

The origins of investing in distressed securities go back to the 19th century. Following the industrial revolution, an increased volume of goods to be transported had created the need for a faster means of transport. Convinced that railways could generate large benefits, the British Parliament ...