Smart-Stock.net

Over at EurekaHedge, there is an informative article by Dean Menegas (General Counsel, Spinnaker Capital Group) about distressed asset investing that is worth summarizing.  One especially relevant point Menegas makes is that a distressed asset is “severely depressed for a reason particular to the issuer and not because of general market conditions.” With all of the doom and gloom at play in the U.S. market today, this is a point worth remembering.

Menegas goes on to distinguish between several types of distressed assets.  An event-driven distressed investment is one in which a specific event or change will increase the value of the asset at a later date.  Examples of this are debt restructuring, asset liquidation, or outstanding debt buyback.  Once the specific event has occurred, investors will see a gain from re-pricing of the asset.  A valuation-drive investment is one in which a distressed asset is purchased without a “transformative event” in sight.  Investor profit potential lies in either the market (price increase due to improved credit), cash flow, or a transformative event that increases the price.

Menegas stresses that wise investors don’t simply buy distressed assets because they are cheap.  Instead, they buy low-cost assets that have a reason to rise in the future- there must be a clear future value, even if the date of this increased value is uncertain.  Investors must therefore be prepared to hold onto distressed assets for as long as it takes for the changing marketplace to increase their value once again.

For investors, this means that research, patience, and sufficient resources are necessary in order to invest wisely in distressed assets.  So, while those around may be crying chicken little, wise investors know that even an economy in crisis offers up opportunities for profit.

Let’s be frank. Investors are all looking for the same thing- a solid return on their investment. In boom times you may have to choose between a relatively modest return on investment rather than a very strong one, but when times are tough, many investors have to take what they can get. These days many people are seeing their stock value decline, but feel like they cannot sell during a downswing because they’re afraid of taking the hit. People are wary of buying in that environment too because they aren’t sure what investments are on the rise.

The best advice? You should have at least part of your investment portfolio dedicated to companies that are likely to turn a profit even in a down period. The key is finding counter-cyclical growth.

There are a number of companies out there that fit that bill, but the ones that seem most promising in this market are the ones that can both make a profit during the downturn and see an even greater increase when the economy hits its stride again.

So what strategies work best in this economy?

Smart investors will look for the niches that benefit from the new marketplace. For instance, with all the talk about the mortgage crisis, a number of large banks are looking to get these mortgages off of their books. It’s in the banks’ best interest to clean up their balance sheets, and so they are willing to sell these assets at a lower rate than most people would guess.

The end result? Banks are now willing to get rid of assets like mortgages at dimes on the dollar. Smart companies (particularly those with the wealth management experience and knowledge to do proper analysis of the loans) can pick up performing loans at a low cost. And because the initial investment was relatively small, they only need a portion of the total number of mortgages to follow through in order to recoup their investment and see a strong return. Just think of what returns they can see when the economy becomes stronger and the rate of foreclosure returns to a normal level!

Another thing that people need to consider is that, even in the worst of the housing market troubles, when foreclosures reach a 6% rate on an investment that holds hundreds of mortgages, 94% of the loans are still performing! If you do the math, the return on investment is higher in this area than in almost any other area.

It seems incredible, but the secret is starting to get out. Take advantage of the economy, before it starts to take advantage of your investments…