CandleFocus

Distressed Securities

Distressed securities are issued by companies that are on the edge of, or en route to, bankruptcy. It is common for foreshadowing indicators to be seen in the form of breached covenants from the security issuance, which is often an initial sign of oncoming bankruptcy. While it may seem absurd in nature, some investors known as ‘hawks’ find investment opportunities in distressed securities due to certain advantages.

In particular, distressed securities often offer the potential for a high return on a short-term basis, as well as a higher cap rate in the long-term. This means that investors of this type can quickly and easily capitalize on the ‘fire sale’ prices that distressed firms offer in return for an out of the ordinary opportunity. This can be advantageous in cases where companies are in the process of recovery and need funds to initiate that process.

Notwithstanding the swift profits, there are a few drawbacks associated with investing in distressed securities, however. Namely, these securities tend to be traded less frequently and involve more risk than typical investments. Investors therefore need to be aware of the full economic conditions of the companies they are investing in and must be willing to accept losses and a longer wait for returns. Additionally, the firm’s debt must be closely monitored for covenants that it cannot meet.

In summary, distressed securities represent a high-risk, high-reward option for investors who want to capitalize on a ‘fire sale’ opportunity. While the potential for great returns is there, investors must be aware of the unique risks associated with buying and selling these securities, such as a lack of liquidity and frequent covenant breaches. Those who are willing to accept this risk may be able to reap immense rewards in the form of quick profits and an improved ROI.

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