The Anatomy of Distressed Debt Markets
42 Pages Posted: 11 Oct 2018
Date Written: September 18, 2018
We have often observed, e.g. Altman, Hotchkiss (2006), that the market for investing in distressed securities, (the so-called “vulture” markets), had captured the interest of increasing numbers of investors and analysts. These investors, sometimes categorized as “alternative asset” institutions, mainly hedge funds, now can convincingly argue that the market has matured into a genuine asset class, with a reasonably long history of data on return and risk attributes. And, we have been there every step of the way, researching its growth and performance, documenting its dynamics and nurturing the asset class growth with statistics and analytics.
Our fascination with distressed firms and their outstanding securities began when the Chairman of an investor enterprise, The Foothill Group (now part of Wells Fargo), came to me (Altman) with an assignment to provide a descriptive and analytical “white” paper on what was generally known as “distressed” debt. This resulted in two monographs, one on Distressed Bonds (Altman, 1990) and a second on Distressed Loans (Altman, 1992). Our first task was to carefully define this market, after getting several interesting, but not sufficient, definitions from practitioners, such as bonds selling for less than 80% of par value. We established essentially two precise categories: (1) bonds or loans whose yield to maturity (later amended to option-adjusted yield) was equal to or greater than 10% (1,000 bps) above the 10-year U.S. government bond rate (later amended to be the U.S. government bonds with comparable duration) and (2) those bonds or loans of firms who have defaulted on their debt obligations and were in their restructuring, usually Chapter 11, phase. The former was categorized “Distressed” and the latter as “Defaulted”. We also included the equity securities of those firms, but did not attempt any documentation on distressed equity at that time.
In addition to an increasing number of articles and reports on the Distressed Securities market and to the two aforementioned studies, several books related to the subject have been published (see our Literature Review, later). The purpose of this article is to document the descriptive anatomy of the distressed debt markets size, growth, major strategies, characteristics, and participants, and then to explore its performance attributes, reviewing the relevant 30-year period from 1987-2017.
Keywords: distressed debt, vulture investing, high-yield bonds, hedge funds
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