What Are Distressed Securities?

Investopedia defines distressed securities as:

“financial instruments issued by a company that is near to or currently going through bankruptcy. As a result of the issuing company’s inability to meet its financial obligations, these financial instruments have suffered a substantial reduction in value, but because of their implicit riskiness, they offer investors the potential for high returns.”

Through experienced and a disciplined process of research and due diligence, Schultze Asset Management specializes in turning these distressed market fluctuations into positive returns. By pairing these securities that hold below ideal credit ratings (allowing for maximum potential risk to payoff ratios) with in-depth analysis of the marketplace, we aim to identify which of these distressed securities are likely to result in returns.

When Is A Security Considered Distressed?

Whenever a company is unable to meet a wide-array of its financial obligations and debts, any securities concerning them are labelled as distressed. Debt-rating agencies will typically rate these bonds in the vicinity of the CCC range. Because of this they have a large return when compared to most types of investment, typically with a rate of 11% or higher. When stacked against low-risk forms of investment with a return in the area of 1% (such as U.S. Treasury Bonds), the potential of more than 10 times more a return makes them a potentially lucrative investment, especially when included as part of a diversified portfolio.

Schultze Asset Management On The Topic Of If Defaults Are Distressed

Founder George Schultze talked about the differences between defaults and distressed opportunities in a recent article for Forbes online. Check out this excerpt:

“Investors are also looking anxiously toward Congress to see if the Republican majority will be able to achieve its long-sought goal of rewriting the tax code. Although as of this writing all of the particulars had not been worked out, the proposed legislation has the potential to give the economy a boost by lowering corporate rates, encouraging repatriation of offshore profits and closing down international corporate tax loopholes.

In an environment still filled with so much uncertainty, it appears that equity exposure still makes more sense than allocations to fixed income, particularly securities with long duration. But it’s important to remember that all equities are not created equal and that investing shortcuts, like low-cost ETFs and index funds may actually increase risk without providing the downside protection investors seek. In many cases, the active approach of well-established alternative investment managers who have demonstrated an ability to manage through multiple market cycles will produce better overall results.

Faced with this continued uncertainty, value-oriented equities, particularly those of formerly-distressed companies trading at a significant discount to fair value, appear to currently present some of the best opportunities for investors.  The key thing to remember is that extremely-cheap companies usually don’t stay that way forever. The market may not always be perfectly efficient in pricing distressed securities but usually that condition doesn’t persist for the long-term, as shown by numerous catalysts, such as stock buybacks, special dividends, and M&A transactions, that we’ve recently seen help to narrow the valuation discount for certain companies.”

The full article can be read here.

Digging Deeper Into Distressed Securities

Are you interested in learning more about distressed securities investing? Check out our distressed securities page for more advanced info, including in-depth articles and videos!

You might be interested in looking at our other Schultze Asset Management site.