George Schultze Contributor
I wrote the book on vulture investing.
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INVESTING
3/08/2017 @ 10:26AM 77 views
Rising Rates Should Create Ample
Opportunities for Distressed Investors
A rising tide lifts all boats and investors of all
stripes continue to benefit from a bull market
that will celebrate its eighth anniversary this
month. Whether that upward momentum can
continue and for how long, is the big question at
the moment and one that Wall Street is
struggling with.
Photo Credit: Bloomberg
Looking at the current macroeconomic landscape
leads us to conclude that investing in U.S.
companies makes much more sense than
allocating capital to other primary markets such
as Europe or China. Moreover, rising interest
rates increase the likelihood that we will find an
even greater supply of over leveraged companies
going through difficulty in the near future, which
should provide distressed investors with an
ample supply of investment ideas.
The strong performance of the equity markets
last year has only intensified the ongoing debate
over the continued relevance of active money
management in general, and alternative
investments in particular. In our view, active
fund management will always be relevant no
matter how much money flows into passive
strategies like ETF’s. In fact, we believe that as
more money flows into ETF’s, it becomes more
likely that new market inefficiencies will be
created that can be exploited by smart active
managers.
Experience has also demonstrated that investing
in distressed securities is a specialized discipline
that simply cannot be replicated through passive
management. Nor at this point in time can it be
done by a machine. At its heart, distressed
securities investing is the ultimate value
investment strategy. It remains one of the few
places left in our markets where inefficiencies
(such as those created by forced sellers,
misunderstood litigation, or complex
restructurings) can yield outsized event­driven
profits to investors who know what to look for
and do their homework.
There was substantial distressed activity last year
and 2016 ended with the fifth­highest yearly
default total on record. During that twelve month
period, 62 companies defaulted on $59.3 billion
in debt—57% higher than the $37.7 billion of
defaults in 2015 according to J.P. Morgan. If we
add so­called “distressed exchanges” into the
mix, the total rises to 91 companies defaulting on
$68.5 billion in debt in 2016 (+33% vs. 2015).
Clearly, distressed securities activity is busy. As
of February 1, 2017, the U.S. high­yield corporate
bond default rate (including distressed
exchanges) was 4.3% while the U.S. high yield
corporate loan default rate was 1.6% according to
the same source.
Within distressed securities, we have seen robust
activity in a number of industries, particularly
the metals/mining and oil & gas sectors, in this
default cycle. Surveying the current landscape we
see and/or expect future distress in the following
industries:
Auto suppliers (post­distress
equities, stock buybacks)
Auto manufacturers (post­distress
equities, dividends, spinoffs, stock
buybacks)
Casinos (post­distress equities, pre­
bankruptcy shorts, distressed debt)
Coal (legacy liabilities, distressed
debt, reorganizations, post­distress
equities, regulatory change)
Energy (low prices, pre­bankruptcy
shorts, distressed debt,
reorganizations)
Financial Services (post­distress
equities, regulatory change)
Governments­local/state/federal
(excessive debt, legacy liabilities)
Industrials (legacy liabilities, M&A,
post­distress equities, volatile
commodities)
Litigation Claims (creditor litigation,
mass torts, misunderstood liabilities,
liquidations)
Publishing (distressed debt, post­
distress equities, legacy liabilities,
secular change)
Real estate (post­distress deals,
M&A)
Retailers (changing technology,
excessive debt, under­utilized real
estate)
Shipping (distressed debt, post­
distress equities)
Telecoms (legacy liabilities, M&A,
post­distress equities, secular
change)
Transportation (legacy liabilities,
post­distress equities)
Utilities (post­distress equities,
volatile commodity inputs)
With current macroeconomic trends, individual
security selection will likely demonstrate its
importance once again, helping to further make
the case for active management. In the U.S., we
expect higher growth, a steeper interest rate yield
curve, and a more business­friendly environment
going forward. And looking at the expanding
opportunity set in distressed securities we are
overall very optimistic about 2017.
George Schultze is a hedge fund manager and the
founder of Schultze Asset Management. He is
the author of The Art of Vulture Investing:
Adventures in Distressed Securities
Management.
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