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From Crisis to Opportunity: Identifying the Challenges of Distressed Investing

The year 2024 presents positive business outcomes for Distressed Debt according to leading thought leaders in Distressed Investing. However, investors must proceed with caution, carefully researching and studying the business landscape first as the Distressed Debt Investing arena presents a formidable array of challenges.

To ensure success in handling distressed debt investing opportunities, one must always be mindful of the pitfalls and stay ready to take on these challenges head-on. Here are some time-tested, effective strategies from prominent thought leaders in business investing to help you overcome the risks and challenges in Distressed Debt Investing.

Strategy No. 1:

Make decisions based on complete Financial Information.

Due diligence in distressed debt investing is often limited to a company’s public records. According to Harvard Business School Online news, investors may not have comprehensive insights into the company’s finances, leading to investment decisions based on an incomplete picture. Thus, before making business decisions, diligent data gathering MUST be performed.

This strategy is best coined in a quote from Matt Wilson, Portfolio Manager of Oaktree Capital Management,

“Perform Financial Statement Analysis. Financial statements are among the most important resources at your disposal when it comes to decision-making. You should not only know how to read them, but interpret and analyze the data they present.”

Strategy No. 2:

Always be ready to take on competition brought about by other savvy investors.

The imminent challenge for Distressed debt investors is the competition with other savvy investors. The slow accumulation of a company’s debt by other investors could result in their gaining majority share or seniority, leaving latecomers with fewer growth opportunities, according to Harvard Business School Online news.

Savvy investors usually focus their attention on investing in distressed companies that can be successfully turned around. The quote “A good company with bad financial statements;” from Matt Wilson, a portfolio manager at Oaktree Capital Management exactly expresses the sentiment.

Strategy No. 3:

Put competitive advantage first.

Distressed companies often face operational inefficiencies, declining revenues, and legal or regulatory hurdles. But if a company displays a high ROIC (Return on Invested Capital) indicates that its business model is moved forward by competitive advantage. Investors need to evaluate such risks and the impact on potential profits and must swiftly but cautiously act on improving these areas to ensure successful investment returns. In addition, analyze the distressed company’s business model intensely and push its competitive advantage.

In an article from the McKinsey and Company on the Ten Rules of Growth published in August 12, 2022, the first key rule for growth is:

“Put competitive advantage first. Start with a winning, scalable formula.”

The graph below illustrates successful fund returns when the business model is strengthened, and the competitive advantage of the business is properly pushed and managed.

Strategy No. 4:
Establish Clear Distressed Debt Management Strategy.

Distressed debt fund managers have struggled to raise capital in the past years. To achieve high returns of investments, the investor must not only manage their investing strategy well, but also have a clear and effective distressed debt management strategy. From a blog post “Navigating the distressed debt challenge” of the Strategy& a consulting firm that is part of the PwC network, a clear distressed debt management strategy begins with acquiring distressed debt, and then, active participating in restructuring, and effectively managing risks to maximize recovery and returns.

Kevin Kaiser, Senior Director of Wharton’s Harris Family Alternative Investments Program, emphasizes the changing landscape and the need to have a clear management strategy for distressed asset investing:

“The market will be flooded with opportunities, and investors are ready to move on to them. But the asset class has changed, and knowing how and what today’s market requires is a key to seeing returns.” He highlights the need for both investors and companies to adapt to recent changes in distressed asset investing.

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