Someone’s pain another’s gain

 Distressed investing - either in debt or equity - has taken on a new significance in the current crisis but there are lessons for investors from previous recessions.

According to a client note from Cambridge Associates (see Research Library), the distressed indices only contain about 20 years of data and only two US recessions have been covered in that period. However, following both those recessions - in 1990 and 2001 - highly distressed debt significantly outperformed the US equity market and high-yield bonds strongly outperformed as well. In both cases, highly distressed debt and high-yield bonds hot lows within three months of the equity market, Cambridge Associates observes.

In 1990, the low points for all asset classes were hit within the contraction period and began their recovery before the business cycle trough. In 2001-2002, all asset classes hit their lows nine months to one year following the business cycle trough.

The consulting firm says there are four important components to implementing a distressed strategy:

• Form a plan - dedicate part or all of a committee meeting specifically to decide how to approach distressed investing and answer key questions about liquidity issues, where it fits in a portfolio and diversification.
• Develop a framework of distressed market opportunities - most opportunities are accessed through credit markets.
• Take inventory of distressed investment exposure - most hedge funds have some underlying exposure to distressed securities. High-yield funds are likely to have exposure to distressed companies and deep-value and turnaround opportunities will have distressed components.
• Build out the portfolio - Myles Gilbert, a specialist consultant, says: “It’s impossible to know the timing. The markets move quickly. So, I would caution anyone from trying to make a big investment in a specific distressed area and instead consider delegating to multiple managers.”