During the pandemic, the market was in turmoil, but he spent about $1.5 billion scooping up assets. Amid the carnage caused by the fears around the coronavirus pandemic, he’s seeking more commitments for his hedge fund for the first time since 2011. In addition to cash, the firm had about a third of its portfolio invested in public equities and about 17% in distressed securities.
Seth Klarman is the CEO and portfolio manager of The Baupost Group, L.L.C., which currently manages approximately $30 billion hedge fund. Klarman is seen as an expert in value investing. His book “Margin of Safety,” a cult classic among investors, sells for as much as $1,000 on Amazon. But Value Investing is too broad of a topic. In the article, we will talk about the specific strategy he uses to generate consistent returns. It is called distressed securities investing.
You might wonder why a hedge fund — or an investor, for that matter — would want to invest in bonds with such a high default risk. The answer is simple: The greater the level of risk you assume, the higher the potential return.
There is no strict rule for when to categorize a debt as distressed, but it generally means that the debt is trading at a significant discount to its par value. For example, suppose a company is worth $1 billion. The company is in financial trouble and faces the risk of bankruptcy. Its valuation plummeted to $100 million. But you realize that even if the company goes bankrupt and sells its assets such as factories, buildings, and machines, it’d still be worth over $100 million. Therefore, investing in these companies' distress security is almost risk-free.
Generally speaking, the Average Joe is not going to be involved in distressed debt investing. Most people are better off investing in stocks and standard bonds because it is simple and far less risky. But an individual can access this market if they choose. Some companies offer mutual funds that invest in distressed debt or include distressed debt as part of a portfolio.
