There are many investors in the U.S. For example, 61% of adults, or about 158 million Americans, own stock, and over 24 million “accredited” investors can buy private securities, including hedge funds, venture capital funds, and private equity. Another class of investing is distressed debt investing.

What is Distressed Debt Investing?

Distressed debt investing is an alternative type of investment. Other types include private equity, commodities, hedge funds, and collectibles. It is a capital investment in the debt of a financially distressed business, public organization, or government entity. These are typically troubled entities where revenues and margins are seriously declining, and the business may be at risk of default or bankruptcy. Distressed debt investing also includes purchasing corporate debt, including bank loans, investment-grade bonds, and high-yield bonds at a deep discount.

The Benefits of Distressed Debt Investing 

The benefits are buying at extremely low valuations or inventing in an entity that has mispriced itself below true market value due to its problems. Thus, later returns can be much higher. The distressed market is less crowded than high-performing categories such as technology companies. Higher returns can be obtained through restructuring or from payouts in the case of bankruptcy. Contrary to other types of investments, the opportunity is on the downside. As Warren Buffet has said, “The best chance to deploy capital is when things are going down.”

Common Opportunities in Distressed Debt Investing 

Some common opportunities in distressed debt investing include investing in distressed companies that operate in profitable sectors and purchasing distressed debt from mutual funds. 

What are the Risks? 

The risks are, first, that distressed securities can have highly volatile prices because one or more investors may want to get out, thus causing the security price to move significantly. Second, there can be a high risk of capital loss, especially if an investor doesn’t know what he/she is doing. Third, some distressed investments can be highly illiquid, making it difficult to get out of an investment quickly. Fourth, there may be less information available on how to make good investment decisions. That is especially true with private securities that are not required to issue SEC filings. 

What is the Process? 

Like other types of alternative investments, distressed debt investing requires a methodical approach to secure success and deliver good returns for an investor. The process requires careful research to identify investment opportunities. It requires due diligence to determine how a company got to the point of financial distress and whether the organization’s financial structure can be improved satisfactorily. Investors should carefully project any potential gains that can be derived from restructuring and adding value to the company’s assets and performance. And careful attention should be paid to the potential risks of such investments.

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