Key Takeaways
- • Distressed debt investing means buying the existing debt of a financially distressed company, government, or public entity, often with the goal of gaining a controlling position.
- • Investors target "a good company with a bad balance sheet," according to Oaktree Capital Management portfolio manager Matt Wilson, citing financial distress, a viable business model, and in-demand products.
- • Control can be pursued through restructuring, where a controlling debt position lets an investor influence the process and emerge as an equity owner, or through bankruptcy, where debt holders are paid before equity holders.
- • Key risks include limited due diligence to public information, competition from other distressed investors, and the possibility of renewed financial distress after restructuring.
- • Distressed debt is typically a small allocation within a broader portfolio, given its high-risk, high-reward profile.
Summary
This Harvard Business School Online primer outlines distressed debt investing, a segment of alternative investments that also includes private equity, commodities, hedge funds, and collectibles. Alternative investments are generally illiquid and not regulated by the U.S. Securities and Exchange Commission, according to the article. Distressed debt investing, also called distress debt investing, distressed investing, or distress investing, involves purchasing the existing debt of a financially distressed company, government, or public entity. A company is considered distressed when its capital structure is unstable, such as when its debt load is too high or difficult to refinance, or when it cannot meet its debt covenants.
Investors typically look for financial distress, a successful underlying business model, and an in-demand product or service. Matt Wilson, a portfolio manager at Oaktree Capital Management, described the target as "a good company with a bad balance sheet" in the HBS Online course Alternative Investments. Investors aim to acquire a controlling stake in the debt, which can be used in two scenarios: restructuring, where a controlling debt holder can influence the process and become an equity owner, or bankruptcy, where debt holders are paid before equity holders if assets must be liquidated.
The strategy is adversarial by design. Because owners and management often have a hostile relationship with distressed debt investors, buyers may accumulate debt gradually from other holders to avoid signaling their intent. Research is generally limited to public information, such as public financial records, and investors may not know whether rivals are pursuing the same position. Victoria Ivashina, a Harvard Business School professor who teaches the course, describes distress investing as "an intricate game of strategy where investors try to anticipate and indirectly influence the company's financial decisions." The article illustrates capital structure choices using term loans, which are contractually senior to bonds, and notes that under U.S. bankruptcy law two-thirds of bondholders must agree to give loan holders equity, so an investor holding two-thirds of the bonds could control the restructuring vote but might not be paid out first.
The article identifies several risks: limited access to financial information, competition from other investors who may become "accidental partners" able to block efforts, and the risk that a restructured company falls into distress again. Potential benefits include high returns from successful restructuring and recovery in bankruptcy, where purchases made at low prices may still yield a positive, if less substantial, return. Given this risk-return profile, the article notes that distressed debt is often held as one component of a diversified portfolio.
Investors typically look for financial distress, a successful underlying business model, and an in-demand product or service. Matt Wilson, a portfolio manager at Oaktree Capital Management, described the target as "a good company with a bad balance sheet" in the HBS Online course Alternative Investments. Investors aim to acquire a controlling stake in the debt, which can be used in two scenarios: restructuring, where a controlling debt holder can influence the process and become an equity owner, or bankruptcy, where debt holders are paid before equity holders if assets must be liquidated.
The strategy is adversarial by design. Because owners and management often have a hostile relationship with distressed debt investors, buyers may accumulate debt gradually from other holders to avoid signaling their intent. Research is generally limited to public information, such as public financial records, and investors may not know whether rivals are pursuing the same position. Victoria Ivashina, a Harvard Business School professor who teaches the course, describes distress investing as "an intricate game of strategy where investors try to anticipate and indirectly influence the company's financial decisions." The article illustrates capital structure choices using term loans, which are contractually senior to bonds, and notes that under U.S. bankruptcy law two-thirds of bondholders must agree to give loan holders equity, so an investor holding two-thirds of the bonds could control the restructuring vote but might not be paid out first.
The article identifies several risks: limited access to financial information, competition from other investors who may become "accidental partners" able to block efforts, and the risk that a restructured company falls into distress again. Potential benefits include high returns from successful restructuring and recovery in bankruptcy, where purchases made at low prices may still yield a positive, if less substantial, return. Given this risk-return profile, the article notes that distressed debt is often held as one component of a diversified portfolio.
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