Debunking the myths of distressed investing
For investors, seeking out companies that are in distress offers the chance to capture what they’re all on the hunt for; a bargain. Based on the fundamentals that the assets are drastically undervalued and can be purchased at a discount, distressed investing can be very lucrative for those that do it well. The lower-for-longer price environment has made the energy sector an opportune place for it.
Distressed investing is often regarded as intrinsically high-risk and high-maintenance, intimidating even the most experienced investor. But, not all of these market labels hold true all of the time. Here’s my take on some of the myths that plague distressed investing.
1. Win big, or lose everything
When investing in turnaround situations where the investors believe a company can succeed with some capital assistance, investing in distressed debt is not always a fly or flop scenario. In the event that the company is dissolved, banks favor debt over equity, meaning that even if a company’s stock plummets to zero, debt will retain some of its value. When it comes to distressed debt, investors can win big, or lose some, debunking the myth of win big or lose everything.
2. Investing in distressed debt will risk the rest of my portfolio
One of the positive characteristics of distressed debt is that it’s performance is often relatively unrelated to other factors that affect stock market prices, making it a great way to diversify a portfolio.
3. The window for investment is tight
Depending on what an investor wants to do with the company; either liquidate or restructure, they can invest earlier or later, but the investment time-frame remains flexible. Earlier investments will cost more, but provide greater probability of a successful turnaround. Delayed investment can offer the steepest price discounts and establish the investor as the primary creditor and beneficiary in the event of liquidation.
There will always be pros and cons, risks and uncertainty for any type of investment. By educating yourself through informed financial analysis and market understanding, distressed investment can be more attractive that one might originally think.
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