“If you want peace, prepare for war”, goes the Latin military adage. It could well apply to the preservation of wealth during a stock market correction or a recession by planning when the economic environment is benign. Private equity offers interesting strategies for such a purpose, helping investors capitalize on opportunities while other assets suffer from the downward phase of a macroeconomic cycle.

Distressed debt investing is arguably the strategy that capitalizes the most on downturns. The purpose of this type of investment is to take control of a company by acquiring some of its debt at a significant discount during a bankruptcy procedure. The distressed debt fund manager and the management of the company engineer a restructuring plan, which is submitted to the bankruptcy court for approval. This plan usually implies that some or all of the debt acquired by the fund will be converted into equity, after washing out previous owners. The fund the company, restructure it and resell it once the business is on a firmer footing. Companies acquired are therefore fundamentally sound, but suffer from specific adverse events or an excess of debt. They usually have significant assets and an otherwise sound business model.

Distressed debt investing requires efficient and rather quick bankruptcy processes. Proceedings have to be predictable and decisions enforceable. This strategy also assumes that creditors are willing and able to sell their claims at a discount and that their ranking is only determined by the seniority of their credits. Many jurisdictions do not provide such a context. Some, like France, provide a specific status to public claims (they are “super-privileged” and non-negotiable).

Figure 3 – Pooled average TVPI, RVPI and DPI of distressed debt funds

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