Guide: Distressed debt history
by distresseddebt.com, August 2009 updated Sep 2020
Short history – what history?
Distressed debt is a relatively young “asset class”, especially in Europe. While there is no hard definition of distressed debt, the most commonly used definition states that a bond is distressed if it’s option adjusted spread is equal or greater than 1,000 basis points. This definition was coined by the academic guru of distressed, Prof. Edward Altman (http://pages.stern.nyu.edu/~ealtman/). The definition was then extended to loans trading at prices below 80 cents. Given the young age, limited price points and limited transparency, there is limited research in this area of investing which is scientifically sound. The longer it remains this way, the longer there will be opportunities for those skilled in this area of investing, we dare to say.
Following the credit crisis in 2003, the returns of distressed funds had been staggering and did not go unnoticed. At the time distressed investing was considered an underdog and dirty job for the very few. It was only around 2003 and the energy crisis in Europe that US style distressed debt investing arrived. The European high yield market was also in its infancy at the time!
2009 and 2010 were great years following the great financial crisis (“GFC”). Interestingly the company that defined the GFC, the default of Lehman, was and has been one of the best trades in distressed since! Recoveries are still being received now in September 2020.
2011 and 2012 we had the European crisis, driven by Sovereign spreads in Southern European countries exploding. Greece was the first but other southern countries followed with the infamous PIIGS acronym. Ireland being the one exception from the North.
End of 2015 and early 2016 we saw the oil crash from over 120 USD per barrel to just under 30 USD within about 6 months. This saw a huge default cycle in the US but also little Norwegian bond market. Traditional European high yield market was spared mostly as it has had limited exposure to Energy bar some African names (which got ugly).
Performance since 2017 in distressed has been rather poor. Based on the EDHEC distressed index, my current favourite source, the space has actually delivered negative returns, and that’s also before taking into account the COVID-19 “wobble”.
2020, as defined by the Covid-19 pandemic, was a great trading opportunity, if you got your timing right. March was the bottom, followed probably by August being the top. Personally, I would say that investment grade in March before the FED backstop was the best trade opportunity, but distressed didn’t do bad. The 2020 March bottom is probably among the most hated bottoms, because it moved so fast and so few actually had a chance to take advantage of it. Also, one has to remember that most distressed funds did have investments on the books and those were and most probably still are in deep trouble.
2021, well I wish I can forecast the future, but our assumptions are that Governments and banks have supported everyone they could in 2020 but the funding and free extensions will have to end and someone will get the bill. On this basis we see a very 2021 for distressed debt. The again all the equity strategists are saying how 2021 will be an amazing year for equities, doubt it will be great for both!