Distressed investing is a sub-strategy within the realm of alternative investments, often capturing the attention of investors looking for unique opportunities in challenging market conditions.1
For the uninitiated, distressed investing focuses on generating a favorable outcome from investments in troubled companies or distressed assets, with the aim of recovering value.2 However, it's not without complexities and risks.
Here are five things that investors and advisors may want to know about distressed investing:
1. Types of distressed investing
Distressed investing can be broadly classified into two types – control and non-control.3 Non-control investments typically involve passive trading strategies where an investor believes a security is undervalued. The aim here is to acquire such securities at a lower cost, hoping for a value appreciation over time.3
On the other hand, control investments involve situations where the investor takes control over the distressed asset or company and actively manages it to increase its value.3 This is a more hands-on approach, often involving significant operational and financial restructuring efforts.3
2. Navigating the specialized landscape
Distressed investing is a highly specialized investment strategy.4 A relatively small number of investment managers are focused on this area, each with their unique investment approach and philosophy.4 These managers often possess deep industry knowledge, specialized skills, and the ability to navigate complex legal and financial landscapes, all of which are critical to potentially unlocking value from distressed assets.4
3. Timing is key
While distressed investing can be an interesting strategy during any period, it often comes into its own during periods of market dislocations and economic downturns.5 These are times when more companies generally face financial hardship, usually leading to an increase in distressed assets available for investment.5
However, it's important to remember that investing in distressed assets is not about taking advantage of others' misfortunes but about providing much-needed liquidity and operational support to struggling companies.
4. Recovering value from mismanaged assets
Distressed investing often involves identifying assets that have been mismanaged and where value can be recovered.1 This requires a keen eye for operational inefficiencies, sub-optimal capital structures, and other sources of financial distress. Generally, distressed investors are not only practiced at identifying such opportunities but also at potentially implementing strategies to turn around the fortunes of these assets.4
5. Risk considerations
It's important to note that distressed investing typically involves a high degree of risk.2 While there can be potential returns, investors may also face significant losses if the recovery of value does not go as planned.2
Additionally, distressed investing often requires a longer investment horizon with limited or no liquidity and can involve significant legal and operational complexities. Therefore, it's essential for investors to fully understand these risks and to work with experienced advisors and investment managers.3
Distressed investing may present intriguing possibilities for those willing to navigate its intricacies.1 While the strategy requires specialized skills and a robust understanding of risk, the potential for a favorable outcome, particularly in volatile markets, continues to attract investors.4
1 https://www.financialpipeline.com/distressed-investing-a-long-term-game-for-high-returns/
2 https://online.hbs.edu/blog/post/distressed-debt-investing
3 https://www.chapman.com/publication-us-distressed-investing-a-guide
Market volatility or lack of liquidity could impair an investment’s profitability or result in losses. Factors such as high vacancy, oversupply of the product in the market, increase in interest rates for borrowing loans, bad credit quality of tenants occupying the property, general economic risks such as interest rates, availability of credit, inflation rates, economic uncertainty, changes in laws and general overall deterioration of the market in which the asset sits, all of which could lead to financial difficulties and impact net operating income and can depreciate the value of the property. These factors, in addition to others including increases in the costs in excess of the budgeted costs, the burdens of ownership of real property, environmental liabilities, contingent liabilities on disposition of assets acts of God, pandemics and other national, regional or local emergency conditions, terrorist attacks, and war may affect the level and volatility of asset prices and the liquidity of investment assets.
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