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Distressed SecuritiesDistressed securities is an investment strategy often associated with hedge funds. Fund managers following this strategy invest in the debt, equity, or trade claims of companies either already in default, under bankruptcy protection, or in distress and apparently heading toward such a condition. The theory behind this strategy is that the securities of companies in such straits often trade at discounts to a rational assessment of their risk-adjusted value for a variety of reasons. The psychological effect of a bankruptcy filing may lead to undervaluation, for example. Or institutional investors often have policies that prevent them from investing in such circumstances, and that automatically means a lessening of demand for the instruments, which may again lead to undervaluation. A fund pursuing a distressed securities portfolio might adopt a long only position, although it is also possible to short sell such claims.
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