If market value was an illusion when stocks were soaring, who’s to say it’s no illusion when stocks are flooring?! So say investment specialists Marty Whitman and Curtis Jenson of the Third Avenue Value fund. Arguing for optimism in this article from The Wall Street Journal, Mr. Jenson offers “…unprecedented opportunities in the distressed debt market.”
Calling many current valuations “ridiculous,” the managers at Third Value have pressed ahead with high-yield bonds.
Third Avenue Value has been buying select bonds from GMAC, as well as bonds from a trucking company — Swift Transportation — and expects either a yield at maturity of 19% or a valuable slice of equity if Swift is forced to restructure.
Indeed, in a recent letter to his shareholders, Mr. Whitman predicts some yields as high as 54%.
How do you take advantage of opportunities in high-yield bonds during these difficult times? If Jensen and Whitman are correct, the key is optimism, and a group of investment specialists who know how to value distressed assets.
With such a rapidly-changing financial scene, it might be a good idea to take a step back and gain some perspective. The New York Times has established a timeline detailing the events that defined this financial crisis. Though the picture seems dire, smart investors know that great difficulties also present great opportunities. Where is the light at the end of this seeming chain of dominoes? Read on…
Sept. 7, 2009 — Henry M. Paulson, Jr., justifying the conservatorship of Fannie Mae and Freddie Mac, tells the public that these two government-sponsored entities are “…so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in the financial markets here at home and around the globe…”
Lehmen Brothers, AIG, and even Merrill Lynch — “the thundering herd of brokers around the nation” — fell victim to the crisis. Wall Street resembled a trauma victim as onlookers wondered how to ’staunch the bleeding…’
Ultimately, the government had no choice but to rescue AIG, which was — in words that would become increasingly common in the media sphere — ‘too big to fail…’
Finally, the system seemed to be near the breaking point — even Morgan Stanley and Goldman Sachs could no longer escape regulation, and Washington Mutual became the largest bank failure in the history of the United States. Congress had no choice but to step in with a financial bailout plan. At the time, those seeking returns from distressed assets thought that they might have the government’s backing. Indeed, prior to the bailout, Paulson assured the public that the Treasury was working to “…address the root cause of our financial system’s stresses…illiquid mortgage assets that have lost value as the housing correction has proceeded…”
Ultimately, despite the best efforts of Federal regulators and foreign banks which seemed at first glance better-regulated than U.S. systems, the financial crisis spread beyond the U.S. to the shores of Europe and Asia.
Where is the light at the end of the tunnel? As we noted in our most recent post, there is room for optimism, despite the recent announcement that distressed assets will no longer be the focus of TARP.
And one thing remains certain — investors looking for tremendous payoffs can look to distressed assets that will become increasingly affordable as they are priced to sell. Despite our troubled times, any objective observer would agree that troubled assets will eventually show some return for the investors savvy enough to scoop them up at these bargain prices. For those interested in such potential, a sure-fire bet is to find a team of professionals to guide them in selecting those assets that are guaranteed to win big.
Echoing a recent blog-entry from October 13, Warren Buffett praises the ‘American system’ and advises investors to embrace the government’s program for the economy in this clip from Youtube. Buffet’s penultimate advice: “Be greedy when others are fearful…”
Today, in a stunning reversal, Treasury Secretary Henry Paulson said that the government isn’t going to buy all those distressed assets after all! That is bad news for the taxpayers, who will not get the same return on Paulson’s other “investments”. But it’s good news for people who are willing to buy at a time that distressed assets will be going for rock-bottom prices. Don’t take my word for it though, ask the richest man in the world…
How does Buffett feel about investing in distressed assets? It’s a sure bet. Buying distressed assets at distressed prices is a proven method to make money, according to Buffett. The government wouldn’t be spending taxpayer money, says Buffett, but investing it.
Where others see difficulties, Buffett sees opportunity.
“Confidence will come back,” he says. Buffett offers that the American economy has created a seven to one increase in the U.S. standard of living over the last century, despite the difficulties of two world wars, a flu pandemic, and even the Great Depression. Likening the American economy to an athlete who is ‘down but not out,’ Buffett says, “We’ve got all the ingredients for a sensational future.”
Now that the government isn’t buying, you can bet the prices for distressed assets will be lower than ever. If you can find a team with the expertise to filter out the good loans from the bad, you will make a pile of money.
Earlier this summer, TheStreet.com Financial Advisor Richard Widows offered some good advice for those interested in distressed asset investment. He addresses two basic points: when to invest and what to invest in.
Widows admits the obvious, which is that there’s no universally known “best time” to invest in distressed securities. He does state that markets have a tendency to anticipate early recovery (although admittedly, this was published in June, before the $#@! hit the fan in the U.S. economy).
As to the question of what to invest in, Widows has a bit more to say. In a word, diversification. Diversifying one’s holdings is a wise plan, and one way of achieving this is to purchase shares in mutual funds that invest in distressed assets. Many such funds offer “dollar cost averaging,” which spreads out investments over time. This helps address the question of when to buy, since the fund will best decide that.
Widows suggests four different that specialize in distressed asset investments. The Franklin Mutual Recovery Fund invests in distressed companies, risk arbitrage, and securities special situations/undervalued securities. The Masters Select Focused Opportunity Fund specializes in distressed companies, including high yield bonds, bank debt, and other indebted company purchases. The Highland Credit Strategies Fund invests domestically and internationally in a variety of different areas: fixed rate loans, bonds, debt obligations, and mortgage and asset-backed securities. Finally, the Pioneer High Income Trust invests 80% of its assets in high yield debt, distressed, and convertible securities, loans, and preferred stocks.
It’s likely that there are other funds out there focused on distressed asset investments, as well as companies that can offer helpful distressed asset investment advice. If you want to learn more, do yourself a favor and read some of the other Smart-Stock blogs on the subject.
If you are considering an investment in distressed assets, you might want to take a global perspective.
As reported in a May ‘08 article on Bloomberg.com, Asia is on its way to attracting $10 billion in funding for distressed asset investments, with a projected rise of returns, according to Paul Jurie, who heads Standard Chartered Bank’s alternative investments division.
Certain countries like India and China, real estate companies, and industries that cannot pass higher production costs onto customers are those most likely to create distressed asset investment opportunities. Hedge funds and commericial banks (Barclays, Calyon, Standard Chartered) are those investors most active in buying up distressed assets, with about $3 billion currently invested.
Jurie explains, “I am confident that 2009 will be a good year for distressed asset investments…I recommend you invest cautiously in the next six months and more aggressively thereafter.” He also added that India and China are particularly prone to rising borrowing costs, increasing fraud, unwise management decisions, and economic slowdown, all of which lead to increased opportunities for distressed asset investment.
Since financial matters tend toward the labyrinthine, it might be helpful to get a very straightforward refresher on distressed asset investing. This link does a good job of presenting an understandable description.
The analogy that author Murray Priestley makes is that of a garage sale. What might cost a dollar retail is obtainable for pennies used. By definition, a distressed asset is one purchased from a company in dire financial straits, which is selling its assets for extremely low prices (”everything must go!” etc.). It’s important to distinguish between the flailing company and the assets themselves, which might be capable of fetching a great price at a later date.
It’s possible to invest both directly and indirectly in distressed assets. Direct investment is the act of buying and selling the assets yourself, and can be very very profitable. Indirect investment is the practice of investing money into a distressed asset fund, which buys and manages the funds for you. While more cautious, this method is often more prudent and ensures a more diversified portfolio of different accounts.
Priestly sums it up well: “The growth opportunities are massive for companies as assets are available that, in a bullish market, would have been too expensive.”
According to the August 1st Reuters article, Lehman brothers are hoping to find a domestic or foreign buyer, and will possibly provide funding for the sale. Additionally, they might have hired Lazard Ltd financial advisory and asset management firm to assist them in locating buyers.
Lehman Brothers and Merrill Lynch are part of trend here, one of Wall Street banks looking to unload their risk-laden mortgage-backed securities to those investors with enough boldness, patience, acumen, and cash to hold onto these distressed assets until they become sellable again.
Still rich from the credit bonanza of years past, private equity firms are able to keep their distressed asset accounts during the current economic slump and sell them for big profits when the market has regained its footing. Hedge funds are answerable to investors each month, and thus must be more conservative.
According to Chris Goekjian, chief investment officer at Altedge Capital, “Private equity players have locked-in money. Distressed hedge funds can have quarterly or annual redemptions rights, so they definitely can get money pulled. If they take on larger deals and get redemptions, it hurts.”
In an about turn, private equity firms are now financing the very banks that used to finance them. Major banks like Citigroup and Merrill Lynch are unloading distressed assets for pennies on the dollar to private equity firms. Within the last year, such firms have purchased $25-30 billion of distressed assets from these banks.
Mark Fennessy, restructuring partner with the London-based Orrick law firm, thinks these private equity firms have a clear edge: “They have the analytical and restructuring talent combined to ensure they can get deals. Certain hedge funds lack real experience of having these deals.”
It’s inevitable that the economic marketplace will right itself again, and when it does, all these distressed assets could prove to be immensely profitable for these private equity firms.
According to the New York Post, foreign investors have begun purchasing billions of dollars worth of foreclosed American real estate. It’s not hard to see why. REO (real-estate owned) homes have fallen so drastically in value that they are worth anywhere from 31-80 cents on the dollar.
A foreign sovereign (state-owned) fund from Adu Dhabi is one such investor, and has begun investing in distressed U.S. real-estate assets. With a reported $875 billion in assets, this fund has the resources to invest in and make a considerable profit from North America’s foreclosed homes.
Mark Hanson, a consultant for Field Check Group Mortgage, has been hired by an unnamed foreign sovereign fund to search for particularly good foreclosed home accounts. He is narrowing his search to REO homes. So far, he has secured an outstanding deal: a $2 billion package of foreclosed American homes, at 31 cents on the dollar.
While these types of deals might still be unusual, they will become increasingly common as America’s financial market undergoes more bank failures and real-estate woes.
Enoch Lawrence, senior VP of CB Ricard Ellis, sums it up: “This type of bulk buy would make an impact on the market. They (foreign sovereign funds) are in a unique position because they have a long time horizon to invest and a cheap cost of capital. It’s actually a perfect time for them to acquire these REO assets.”
It’s not just foreign sovereign funds that stand to profit in this market. If you read more of this blog, you will see notable examples of shrewd U.S. investors scoring audacious deals. If you want to maximize your profits during this economic downturn, you’d be wise to consider working with like-minded investors.
A recent Reuters report states that an increasing number of hedge funds are investing part of their portfolios in distressed assets. A survey of 100 hedge fund managers by the Schwartz Cooper law firm found that more than 60 funds have invested in distressed companies, and almost 40 funds plan to buy assets from such companies within the year.
Richard Bendix, director of the survey, explains it this way: “Hedge funds are under increasing pressure from their investors to perform, but the risks associated with that performance have increased dramatically.”
For investors and fund groups planning to invest in distressed assets, it is paramount that they fully understand insolvency situations, namely, their legal obligations should they be unable to sell their stakes in distressed companies.
These responsibilities aren’t dissuading an increasing number of investment firms. The fund managers surveyed are especially interested in the housing, automotive, construction, and energy sectors as upcoming distressed asset opportunities.
Whatever their inherent risks, it’s becoming clear that distressed assets are a growth opportunity too lucrative for aggressive investors to pass up.
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If market value was an illusion when stocks were soaring, who’s to say it’s no illusion when stocks are flooring?! So say investment specialists Marty Whitman and Curtis Jenson of the Third Avenue Value fund. Arguing for optimism in this article from The Wall Street Journal, Mr. Jenson offers “…unprecedented opportunities in the distressed debt market.”
